An update from our investment partners, J M Finn.
Whenever there are significant political or economic events that have a bearing on client portfolios we look to update clients with our thoughts on their short term impact and also try to provide a longer term assessment on the effects of these developments. Never in my career to date have I witnessed such a universally negative reaction to the ‘fiscal event’ announced by Kwasi Kwarteng on the 23rd September. It was a humiliating week for the UK and one which will go down in history as one of the worst budget events that directly caused a broad-based sell off in UK assets. A very controversial plan, arguably announced at the wrong time in the economic cycle, with no independent oversight, has led investors to question and threaten the UK’s long-trumpeted respect for stable economic management.
I am afraid portfolios have not been immune from the fallout over the last week and indeed since the start of the year. Our exposure to UK gilts, corporate bonds, infrastructure and property exposure has fallen back in response to a significant jump in gilt yields. Sectors exposed to the UK consumer are particularly vulnerable however we are generally light in these areas and have been for some time now. At this stage, we do now see some over-reaction in parts of the market and are assessing whether to take advantage of some very attractive prices, both in fixed income and the UK equity market. Indeed, during the last few weeks we have met many of our companies and core fund holdings to hear directly from them on the impact of higher interest rates and inflation they are likely to suffer and we were, in the vast majority of cases, comforted to hear that they do not believe the current conditions will have a significant negative impact on their long term prospects.
Our overseas bond and equity exposure as well as the global property and multi-asset funds have provided some protection to falling values since the mini-budget but global markets are trying to grapple with the effects of rising inflation and interest rates, as well as slowing growth, and have fallen back this year too. The frustration that we have as investors is the self-inflicted nature of the current crisis for the UK that could have been avoided. Will the Treasury’s plan work? We do not think it will as the UK’s economic fortunes are inextricably linked with those of the US and our European neighbours which are both set for economic contraction over the coming months. Exports to Europe from the UK still represent a significant percentage of our total, even after Brexit, and slowing demand from overseas for UK products and services will, in our view, offset any growth generated from the plan. Boosting domestic demand in a high inflationary environment is a high stakes gamble economically whilst the political ramifications of increased inequality in an already divided country could lead to a short premiership for Truss and a likely general election over the next 12 months, even with the U-turn announced on the top rate of tax. The ‘plan’ may only be in existence until 2025 when a general election must be called by as dictated by the Fixed Term Parliament Bill.
Some other key market observations which remain pertinent to how we manage portfolios: UK equities are 50% cheaper than US peers, when measured on forward Price/Earnings ratios with the UK on 8.7x verses 16.4x for the S&P 500 for 2023. This is the widest discount in years which may attract corporate interest from overseas and therefore we are minded not to further reduce UK equities at this point. Short dated conventional gilts are now showing attractive yields to maturity and many investment trusts across sectors, are trading on historically wide discounts to Net Asset Values (NAVs). Brent Crude Oil and Copper have both fallen 30% since their highs in March, whilst US Natural gas is off 40% since its high in June. Other commodities such as Cocoa, Cotton, Lumber and Corn are all off from their highs too; trends which should help reduce overall inflation over the coming months. As such, we see inflation falling sharply globally over the next 12 months which will allow central banks to ease off on their fight against inflation.
Despite the aforementioned confidence in longer term prospects for our investments, in the short term, economic conditions will remain challenging and we continue to see earnings downgrades coming through across most sectors. The backdrop does suggest that we will have a global recession during 2023 (measured as under 2.5% growth for the world economy) however, we are unlikely to see a global financial crisis akin to that of 2008/09 because the banking sector is in far better shape than it was then. Furthermore, markets do have a tendency of bottoming before the economy emerges from recessionary conditions which we see as coming when interest rate rises cease. Given the market falls seen so far this year, we are getting closer to the point where a turn comes in the market cycle. However we have to accept that we are not quite there yet until we see inflation coming under control.
Investment Director at J M Finn