November Performance Update

“How did you go bankrupt? Bill asked. “Two ways” Mike said, “gradually then suddenly”. That famous quote from Ernest Hemingway’s novel feels very applicable to the question “how is your investment forecast playing out?”

We’ve been talking since the spring about a more positive investment environment for our portfolios. Our thesis has been that as inflation falls away and interest rates peak, investment markets and especially bond markets would stabilise, allowing returns to start coming through. For around 4-6 months markets have fought this view, remaining concerned about high inflation rates, a resilient consumer and ‘higher for longer’ interest rates.

Despite our frustrations, we always believed the data would turn our way. It’s taken longer than we anticipated at the start of the year, but finally in November the tide has swung, led by inflation coming in cooler than expected, and more constructive rhetoric from the worlds Central Banks. UK inflation fell from 6.7% to 4.6% in one month, and US inflation also came in lower than expected at 3.2%. The portfolio range returned between 2.63% (Very Low Risk) and 4.40% (High Risk) in just 30 days. Gradually then suddenly after all (perhaps).

The big question now is whether markets continue to believe that economic data and inflation will slow sufficiently to allow our returns in November to continue. We have seen a big positive move this month in both bonds and equities, and doubtless there will be further swings moving forward, the trend though should now favour our thought process. From our perspective we believe that interest rates have peaked, which is a significant point of clarity to all investment markets. Our baseline expectation for UK inflation is 3% by late spring, which is much more palatable (and normal) for policymakers. We think the chance of further capital losses in bonds is therefore small, which means we should, at a minimum, continue to pick up the income (0.4%-0.6% per month), with a strong chance of further capital upside through next year.

Then we have the remaining uncertainty around whether economies will enter a recession next year. Investors have gone from expecting one this time last year to not expecting one now. We think it is too close to call, though if we do get one, we don’t expect it to be particularly deep in nature. If it does come, we expect it to be good for bond returns, as at some point it means interest rate cuts. Just in the opposite fashion to the last 18 months, as cash rates fall, bonds will become more attractive and see significant flows.

When it comes to equities we remain cautious. There are certainly some pockets of great opportunity, and we still believe over the long run they are the most attractive asset class. In the short term the recession risks are more problematic here however, and we like the fact that bonds offer more income. Where we do have equity risk it is in quality companies with strong balance sheets, therefore holding a preference of safety given the recession risk on the horizon.

Overall November was a positive month. Our view started to play out and returns improved. The investment game does not have an endpoint though, and the challenge is to continue to shift the portfolios as our views around the forward outlook change. We think the foundations continue to be in place for strong returns to be delivered in 2024, but it will depend on some key factors that we are monitoring closely, and just like this year it’s very unlikely to happen in a straight line.