We hope you are keeping well, and that you’ve enjoyed a rejuvenating summer. A ‘return to school’ has helped put an extra spring in this author’s step too, though I concede the productivity gains were likely neutralised by the drama of the Ryder Cup opening day. The ebbs and flows of success made for highly compelling viewing, reminding us of the journey that stock markets often take; though investors will have enjoyed far less reward than European golf fans in recent weeks.

Turning to markets and to reiterate investment momentum eroded further in September, as a stronger dollar, higher oil prices and higher bond yields weighed heavy on risk appetite. For UK investors the weakness of the pound helped mitigate some of the losses on international investments. This dynamic also supported the domestic stock market given the preponderance of globally facing business; with the high weighting to energy companies also helping out. Indeed, in many ways, September mirrored the general performance trends observed in 2022.

As is so often the case, central banks were the likely architect of the major anxiety among investors, as they reaffirmed their commitment to see off the inflation menace. Perhaps the best demonstration of this hawkishness came via the ‘dot plot’; the individual interest rate projections for each US Federal Reserve Board Member and President. Though these projections saw no change in the peak of interest rates, they did reveal a desire to keep them ‘higher for longer’. Though there’s clearly been an underestimation of how resilient the US & global economy would be to higher interest rates, there is also an appreciation that monetary policy acts with ‘long and variable lags’. On that basis a higher for longer interest rate environment likely raises the prospect of a US/UK & European recession at some stage in 2024.

Given this backdrop one would expect equity markets to endure a more difficult period; not least given the impressive recovery in share prices this year. Investors should brace themselves for further volatility on this basis, but we would argue all may not be lost for equity investors. Of most comfort would be the hope any such recession wouldn’t be as severe as more recent episodes. This more benign view hinges upon the apparent absence of major economic imbalances i.e. corporations and households don’t (in aggregate) appear to be facing quite such daunting refinancings challenges (except maybe UK mortgage holders) as in prior economic cycles. We should also remind ourselves that having moved off the zero bound, there are now some interest rates to cut! Such policy options might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm.

Hawkish intent doesn’t necessarily mark a death knell for equities either. Should inflationary pressure recede, then the hawkish rhetoric might fade with it. Looking at the disinflationary pressure within the goods and housing/rental sectors, there are reasons to believe such an outcome may occur. Admittedly the labour markets give rise to concerns of more persistent inflation but, even there, some leading indicators suggest a moderation in wages is possible; specifically falling Job Openings and a decelerating Quits rate. Resilient growth and fading inflation might prove a helpful tailwind for equities in the final quarter; should such circumstance materialise.

Pivoting to China and the persistent challenges in the housing market coupled with the ongoing malaise from its manufacturing (and export) sector is weighing heavy on economic performance. Hopes of an imminent turnaround also appear forlorn, as the absence of any material stimulus is keeping consumer confidence on the back foot. Whilst such conditions retard global growth expectations, and can deliver short-term blows to market sentiment, ironically, such weakness may prove just what the doctor ordered. With the globe’s major central banks articulating their determination to tackle price increases, a Chinese inflationary impulse could prove destabilising to such efforts, threatening further rate hikes.

For the inflation doves, however, energy prices remain the elephant in the room. With Saudi and Russian strategic supply cuts ongoing, further price increases cannot be ruled out. A cooling economy may address some of the supply/demand imbalance, but the bullish narrative of resilient growth and fading inflation could be completely undermined by surging energy prices.

Recognising the outlook remains uncertain, the need remains to seek appropriate levels of diversification to meet the investment challenges. Relative to stocks for example, high quality corporate and government bonds might offer a more defensive return profile in the face of less encouraging growth outcomes, particularly given the increase in yields observed over recent months. Alternative asset classes also assist to help diversify portfolios in a more troubling period for stock markets.

Kind regards,

iPensions Wealth Team

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