Market Update

Overview

A few months ago we highlighted that September and October have, on average, tended to produce poor returns, an effect known as seasonality. We also noted that averages are just that, and not necessarily predictive of future outcomes. Thus, we recommended remaining fully invested in risk assets even if, as Halloween loomed, there might have been the odd bump in the night. Although equities experienced a five percent correction during the period, it did not develop into anything more serious, and as October finished many equity indices were standing at all-time highs. Sadly, the UK market was not amongst them, and, owing largely to its historical and current composition, still has some ground to make up. Even so, it too has participated in the continuing rally.

November, December and January have tended to deliver much better returns historically, with pre-Christmas gains dubbed a “Santa Claus rally”; and new money often enters the market in January, adding to those gains. Given what we have experienced in the last couple of years, it would be typical of the investing gods to turn those odds against us!

Indeed, and not just in defiance of those long-term averages, we do believe that a bit more caution is called for in the short term. Admittedly, we are also aware of another old saying that a “bull market climbs a wall of worry”, however, there comes a point at which the evidence we are weighing begins to tip the scales more decisively in one direction.

The two overriding factors for investors to take into account currently remain the path of inflation and central banks’ reaction to it. We have written in some depth in past commentaries about the factors that are behind the current rise in consumer prices. To begin with, it was clear many months in advance that we would experience a sharp rise in spring of this year owing to the collapse in average prices a year earlier during the initial COVID lockdown. That was expected to be a short-lived statistical quirk, and central bank chiefs adopted the term “transitory” to emphasise that they would not react to it in the traditional manner by tightening monetary policy. This was a well-intentioned move to provide forward guidance as to the supportive nature of policy as we recovered from the COVID-related recession.

So far, so straightforward. However, an extraordinary combination of new factors has conspired to keep inflation indices elevated for a much longer period. These include supply chain disruption in both sea-borne container shipping, and land-based freight transportation at a time of increased demand for goods; labour shortages, which are largely COVID-related, but exacerbated in the UK by Brexit; and a huge squeeze higher in energy prices which stems to some degree from the transition to more sustainable sources of power. Prices for many food crops have also risen substantially, too, again owing to either droughts, floods or freezing.

It is still not abundantly clear whether this is the beginning of a more persistent period of elevated inflation, but central banks are increasingly unwilling to take any chances. They are particularly concerned that expectations of higher future inflation will become more ingrained, and that this will lead to calls for higher wages to compensate which would lead to a classic wage/price spiral. Consequently, the US Federal Reserve announced earlier this month that it will start to reduce its asset purchase programme during November, and whilst the Bank of England’s Monetary Policy Committee declined to raise the UK interest rate at the same time, markets are still expecting base rate increases over coming months. In many ways these are welcome moves because they signal the end of the emergency period embracing the pandemic, but they also constitute a tightening of liquidity conditions which begins to soften the strong tailwind that has propelled financial assets higher.

Conclusion and Outlook

With monetary policy tightening now (at least in the US, with the UK surely to follow) it suggests that the period of peak positive earnings has passed, and it is time for investment managers be more circumspect in their outlook.

That does not preclude further gains for risk assets, so it is important to ensure any investments are managed properly and in line with expert advice, particularly as there is also a higher risk of market volatility and larger drawdowns in the short term.

For the longer term, we still believe that a healthy exposure to equities will remain the optimal way in which in which to defend wealth against inflation – so staying invested, with the right advice, is the best way to meet the inflation challenge.

If you have any questions regarding this update or your own financial planning needs,  please do not hesitate to get in touch on 0117 450 1300.