You may have noticed that bulletins have been a little thin on the ground lately. I love to write, but sometimes finding the time can be tricky. This has been especially true this year, as in addition to hustle and bustle of running a business, I’ve been busy planning a wedding, and undergoing building work at home, which is still underway, and not very conducive to getting your thoughts together and into written form.
In spring I tried moving to a monthly newsletter format instead, with a variety of content, and a shorter lead article. However, I wasn’t fully happy with it, so I’m going back to ad-hoc financial musings (hopefully with increased frequency), combined with a new quarterly investment update. The first of these new style quarterly investment bulletins is due in January 2024, so in the meantime, I thought I’d provide everyone with an update on where markets are up to, and what may lie ahead, as winter fast approaches.
When discussing the tumultuous events of the past 12 months, aviation metaphors have been in abundance, with the debate raging over whether we are on track for a soft or hard landing. So what is happening in markets, and what does this mean for us and our investments?
Please note this bulletin is for general information purposes only and should not be considered personal financial advice. Investments carry risk and you may get back less than you invest. Past performance is not a guide to future performance and the value of investments may fall as well as rise.
Market Review – 2023 – The Story So Far….
One of the main themes driving investment markets this year has been central banks. Every month has been filled with speculation, with much hand-wringing over ‘will-they-or-won’t-they’ continue to raise interest rates. In reality, most central banks just kept on hiking, though with inflation figures now coming down quite sharply, further rate increases finally seem to have been put on hold for now. The general consensus is that we may have now reached peak rates, which if true, is a well-needed respite for borrowers and the economy at large.
It’s worth remembering however, that whilst the rate of inflation has been reducing, this doesn’t mean prices are falling – only that the rate of price increases has been slowing. We’re certainly not out of the inflationary woods just yet.
Another key talking point has been the potential for recession in the UK and other western economies, and whether we may be in for a soft landing, or a hard landing. So what do these terms mean exactly? They are used to describe the two potential economic outcomes of the return of higher interest rates.
The soft landing scenario, is that higher interest rates continue to help cool inflation, enabling central banks to begin cutting rates again in 2024. This would provide relief to households and businesses as the cost of debt reduces again, whilst restimulating a slowing economy before it stalls. In this outlook, the economy could dip briefly into a shallow recession, or avoid one altogether. The metaphorical economic plane comes in to land, touching down smoothly, with the economy and markets soon getting back into growth mode.
The hard landing scenario, is that interest rates have to be held higher for longer than people expect. The Bank of England will no doubt want to avoid history repeating and be mindful of the inflationary saga of the 1970s. Back then, inflation surged, with interest rates soon following suit as Britain scrambled to get the situation under control. This had the desired effect, with inflation falling back sharply, only to resurge a short while afterwards, as rates were cut back again too soon. This is likely to make the BoE think twice about reducing interest rates this time around, until indicators suggest inflation has been well and truly dealt with.
The concern is that through seeking to avoid a double peak of inflation, holding interest rates higher for longer may see the UK economy – and those of other countries facing similar challenges – entering a full blown recession, as the real impact of higher borrowing costs and reduced spending works it’s way painfully through the system. In this example our metaphorical plane comes down hard for an emergency landing, passengers bracing for impact and fire engines at the ready on the landing strip…
Despite this tough environment and the uncertainty that has surrounded the key events of 2023, over the year to date, portfolios have actually performed well considering everything that has been going on. Below you’ll find charts showing the performance of our main tracker portfolios. The first shows year-to-date performance, with the second showing the data over a five year period.
Year to Date Performance
Five Year Past Performance
Market Outlook
Looking back to 2022, some pretty scary stuff was happening around the globe. The Russian invasion of Ukraine shocked the world, whilst the cost of living crisis dominated the headlines, with rising mortgage costs and energy costs spiralling, forcing governments to step in to help protect consumers during the winter. Given everything that was going on, as we entered 2023, the consensus view among economists was that recession and major economic pain was all but inevitable. A hard landing looked like the most likely outcome and it was surely only a matter of time...
Yet, as it turned out, the harbingers of doom called it wrong. Developed economies and their consumers have proven much more resilient than expected. After ten to fifteen years of almost no interest rates, and incredibly low borrowing costs, there were fears that if rates were raised to even 3%, let alone 4% or 5%, the wheels would come off, and economies would collapse. Happily, this hasn’t happened, which is largely what has supported portfolio performance during 2023.
So where are we now, and what might the future have in store?
Well, as ever, trying to predict short-term market movements is a fool’s errand. However, we can look for the signals amidst the noise.
Is a recession still on the cards? The answer is that it’s too early to tell and we’ll have to wait and see. If anything, it is most likely postponed, not avoided. However, happily, the soft landing and shallow recession scenario is the view favoured by most economic commentators. Looking out a little further, over the mid-term, the outlook is actually pretty good, with some green shoots scattered throughout the global economy.
China is growing normally again, after a difficult time dealing with Covid and it’s aftermath. Many supply chain issues have been resolved, and in some cases, shortages of products that were in critically short supply, such as semi-conductor chips, have now been resolved. The US consumer has been super strong, largely off the back of their seemingly unstoppable labour market, with job confidence and high pay giving them the confidence to keep spending, supporting not just the economic performance of the world’s biggest economy, but many others too.
Then there is the rise of Artificial Intelligence, which is being hailed as a financial ‘beacon of hope’ by some. One of the big economic problems of the last decade, was the struggle by many businesses - especially those in the service sector - to increase productivity. AI may be the key that unlocks untapped potential for all kinds of businesses, automating menial and unenjoyable tasks and potentially leading to a new productivity revolution, like that in the manufacturing sector in the 80s and 90s, with the introduction of robotics. Ethical and regulatory issues lie ahead however – and rightly so – as the world considers how best to manage the risks of the AI revolution.
However, challenges still lie ahead, and few more treacherous than those faced by central banks. They must walk an economic tightrope, balancing inflationary pressures, with recessionary fears. Holding rates too high, for too long, will almost inevitably tip economies into recession. Ease out of higher rates too soon however, and there is a risk of a dreaded ‘double peak’ of inflation. The latter was what we saw in the 1970s her in the UK. Having brought inflation to heel, the Bank of England started cutting rates too soon, and can be seen in the chart below, which shows RPI inflation in the UK since 1948.
Conclusions
It looks like we need to endure some more volatility and discomfort with our investments for a little longer whilst we work through these current challenges, however, the mid term outlook still looks promising. Potential rate cuts next year may be the key that unlocks the next growth phase for investment markets.
In the meantime, the upside of high rates is that returns on cash deposits are better than they have been for fifteen years. Make sure that if you have money held in savings, you’re getting a competitive rate of interest. One and two year fixes can be especially attractive for some of your capital, so long as you know you won’t need the funds during that period.
Be mindful of the FSCS compensation limit however, which is £85,000 per person, per banking institution. If you have higher levels of cash that make it impractical or impossible to keep within FSCS limits without setting up a multitude of accounts, remember that NS&I Direct Savers can hold up to £2m per person. Whilst less competitive on rates, these accounts provide full FSCS protection.
It’s also worth pointing out that the current high rates on cash deposits are unlikely to last, and that holding money in cash longer term, is still unlikely to keep up with inflation, likely leading to a negative real return.
Investors have felt some pain in the last 18 months. Bond holdings in particular - which typically make up a significant part of defensive and cautious portfolios - have seen their values pushed lower by rapidly rising interest rates. However, these losses may well be reversed quickly, when interest rates begin to fall again.
Equity markets meanwhile, are always looking ahead. So far the recession that was seen as inevitable this year, has not happened, and whilst it may still do so, a soft landing is still the consensus. We never know when the next bull run has begun until we’re already into it, which usually happens before people have even realised. The only way to catch it is to remain invested and be patient.
Selling long term investments and moving money to cash may provide short term stability, but it is only likely to result in missing the next rally, and buying back in at a higher price is a bitter pill to swallow (and a good way to turn a temporary loss on paper into a real loss of capital). The old adage still rings true – it’s all about time in the market, not timing the markets…
