3rd November, 2023
October Performance Update
October was a turbulent month for global investments. The three main drivers were a continuation of resilient economic data in the US (for most of the month), the Israel-Hamas conflict (in particular the potential effects on oil prices and therefore inflation implications), and the escalation in wider geopolitical tensions. Lately, as October rolled into November, we saw a cooling of economic data from the US.
Equity valuations moved higher initially, and bonds continued to sell off. It didn’t last though, as once yields rise (and capital values fall) to a level which look beyond ‘fair value’, then equities can struggle to climb much higher. In this respect, it is worth remembering that we live in a world where all assets (equities, bonds, cash, property etc) are competing with each other, and therefore need to remain attractive. Once bond yields get to a level where 5%, 6%, 7% + can be earnt without taking too much risk, equities and other assets struggle. There is then a point when the risk and reward between equities and bonds favours bonds, and money flows from one to the other. Perhaps we reached this point in October.
We should also add that the sad situation in the Middle East has created further uncertainty to markets. Bonds are more secure investments than equities in a time of crisis, because they have a fixed repayment date and a consistent income stream. This is a key reason we have been so keen to build our allocations to ‘safe haven’ assets at excellent valuations, as they give us protection should a conflict escalate or a hard recession come about. In October however, tensions rose just enough to make markets worry about the oil price and inflation effects (bad for bonds and equities), but not enough to worry about a full-blown escalation (bad for equities, good for bonds). It was essentially the worst of both worlds.
When you add that to everything else, market prices to the end of October reflected compensation for:
- the possibility of 6-7% interest rates,
- the possibility of another inflation spike,
- the possibility of a recession, and,
- the possibility of either Ukraine or this Middle East conflict escalating further
Now all those things are possible, so it is appropriate to have prices reflect that, but it also leaves the door open for the opposite to happen if the compensation isn’t needed anymore.
On the economic front, we saw a turn in data in the last week of the month. We have been expecting to see this for a long time, and it appears that the interest rate rises of the last 18 months are now starting to bite.
One point of evidence is inflation data, which is consistently cooling. In the UK it will take another step lower when October’s inflation number is released, likely from 6.7% to around 4.5%. Another is the economic data such as consumer spending habits and employment – these have been resilient for so long but are now clearly cooling across all developed economies.
The rhetoric from Central Bankers has therefore also shifted, and they have specifically spoken about an optimistic path for inflation and a need to ‘hold’ interest rates and see what happens next. This is a significant shift, though really only happened in the last few days.
It is a change we have been expecting for some time, and one that we generally see as very positive for future returns. It comes back to the points above about what is priced in – Central Banks are telling us that there is very little chance of interest rates going higher, and that they expect inflation to come lower. That provides markets with confidence that those first two bullet points aren’t needed. The chart below illustrates this well, showing the change in momentum of both inflation and interest rates in the UK.
We therefore exit the month even more optimistic that our central case is on the right path, and we should now see the income yields we have built in, uninterrupted in their impact on portfolio returns. There is every chance for capital upside in addition, though as always it’s important not to expect plain sailing, as the data will continue to ebb and flow.
Overall, to us the chance of materially higher interest rates or inflation is very low. We feel we are overcompensated for taking this risk at present. In addition, whilst there could be escalations in either conflict, there could also be improvements. Bonds tend to flip and become a safe haven in significant geopolitical risks as well, so it feels like we are now being paid even more to own insurance against that.
Don’t get me wrong, it has been another tough and frustrating month for markets. On this occasion it has been geopolitical issues driving the moves, with equity markets correcting as nervousness rose, and most bonds also struggling. UK bonds were about the only place that delivered a reasonable outcome, with most in positive territory in October against the consensus.
Against that backdrop the portfolios continue to struggle to generate strong absolute returns. However, relative to everyone else we continue to perform well. Below we are showing yet another benchmark that we often look at, which represents the average of the top 20 largest (by size) UK wealth managers. We are 3.42% ahead on average in 2023, which by historical standards is a huge margin.
We realise the aim is to put strong positive real returns on the board, and we are frustrated that they are still not coming through consistently. Investing however, is a long game that can throw unknown variables at you from time to time – and we’ve had our fair share of those in the last two years!
At its core, investing is about taking advantage of current opportunities to maximise your future potential. We continue to feel we are well positioned. Charts like the one above support that, with us consistently outperforming our peer group. Moving forward we expect to play our advantage, with between 4-7% per annum of income coming into our portfolios (from low risk to high risk) to underpin returns, and if the data plays towards our central case, then there is much greater potential.