4 October 2022
The knock-on effect of the new UK government’s “Growth Plan” persisted last week, with the domestic sovereign bond market suffering exceptional volatility.
The declaration of significant tax cuts coupled with the previously announced energy subsidy package – which will both be funded through considerable borrowing – alarmed financial markets. The upshot was that government bond yields suddenly grew and, relative to other currencies at the beginning of the week, sterling fell rapidly.
This triggered an intervention by the Bank of England (BoE), so as to bring about stability. Mid-week, the BoE said it would do a U-turn on plans to start selling gilts – instead opting to begin buying them. This communication seemed to appease markets, and bond and currency markets had levelled off by the close of Friday.
While this may have calmed markets for the time-being, Azad Zangana, Senior European Economist and Strategist at Schroders, proposed that long-term questions remain:
“The Bank’s decision to step in to stabilise the gilts markets with purchases makes sense in the short term, but this is ultimately a credibility issue with fiscal policy. This is the wrong time to be acting as lender of last resort when it goes against the Bank’s primary objective of fighting inflation. It seems that the BoE will fight the market instead of hike rates aggressively as the market is demanding, resulting in a worse outlook for sterling.”
Such strife in the UK made equity markets all the more nervous, and they continued to drop last week. Mid and small-cap stocks were under pressure to ramp up sales, with the FTSE 250 declining by 4.5% while the larger FTSE 100 fell by 1.8%.
Indeed, this might prove problematic for UK equity investors in the short term, yet Benjamin Jones, Director of Macro Research at Invesco, said that it has left UK stocks more attractively valued than before. What’s more, given the volatile backdrop, there’s potentially a good opportunity for stock-picking in the UK.
“We remain optimistic on the outlook for UK equities going into the final quarter of the year and 2023, while recognising that uncertainties in the global economy and the geopolitical landscape make the range of possible outcomes wide.”
Interest rates round-up
Q2 GDP figures were modified favourably last week, seeing a slight growth from a small decline. The key take-away here is that this means the UK is not currently in a recession.
Jennifer McKeown, Head of Global Economics Service at Capital Economics, said that this may be a temporary situation, however, as global central bank actions were likely to push world economies into a recession. Capital Economics is now expecting UK interest rates to come to a head at 5%, US rates to peak at 4.5%-4.75%, and Eurozone rates to culminate at 3%.
Growth is set to be slowed by these higher rates, and Capital Economics now predicts that a US recession is all the more likely. Furthermore, it expects the Eurozone to experience a recession, and that fiscal stimulus in the UK will not impede a recession there, due to the adverse financial market response.
Given that investor confidence is weak and further interest rate rises are anticipated, global markets got into difficulties last week. The S&P 500 declined by 2.9% as it reverted to levels last seen in November 2020, with the technology-heavy NASDAQ index rounding off the week 2.7% lower. Moves in Europe were subdued compared to their global counterparts, with the MSCI Europe ex UK index retreating by 0.6%, in spite of the increased threat of recession.
In Asia, meanwhile, Chinese equities continued their recent downward course, as currency weakness and a progressively challenging economic outlook led to a 2.1% weekly drop in the Shanghai Composite.
Martin Hennecke, SJP’s Head of Asia Investment Advisory, says that even though markets are currently markedly down this year, counter-intuitively, this could be an opportunity for those willing to play the long game. He notes:
“Investor sentiment remains poor, while attractive valuations can be found in many places. There are still risks in the global economy, which will always be present in times of general pessimism. However, we should not forget that markets are always anticipatory by nature. Historically, some of the best investment opportunities often coincide with the greatest broad-based investor pessimism.
“In fact, a historical analysis of over 100 years of stock markets actually reveals a surprising negative correlation between economic growth and stock-market returns.”