12th October 2022

In an extremely challenging year for investment markets, we continue to look for some optimism.  While difficult to see through the bad news headlines, there are encouraging signs that inflation in the US may have peaked but we are less confident that the same applies in the UK following the recent weakness of the pound.  As before, though, both the timing and heights of the peaks are less important than the levels at which inflation settles in the medium term.  It remains our view that inflation will prove stickier than central banks would like, and wage price spirals could yet develop.  Against this backdrop and as the US Federal Reserve has already made clear, we expect interest rates to continue to be raised aggressively until there is clear evidence that inflation is tamed.  Higher mortgage and other borrowing costs will only exacerbate the cost-of-living squeeze, and this will impact consumer spending and economic growth.   Interest rates of 5% or more would be extremely painful in the UK economy.

The rout in bond markets in 2022 became a bloodbath in the third quarter as the upward trend in yields and downward trend in prices accelerated.  In addition, prices of UK government gilts were sent into a tailspin in the final week of September after the new Chancellor of the Exchequer announced tax cuts which will almost certainly need to be funded by yet more borrowing.  The re-pricing of bond markets after the distortion caused by years of quantitative easing has been brutal in both speed and scale, giving rise to losses that few could have imagined in an asset class that is meant to be a safe investment.  Bond yields have risen to levels which are beginning to look attractive and competitive, but downside risk will remain until there is clear evidence that inflation is falling, and interest rates have peaked.

Global stock market indices fell further in the third quarter to extend their year-to-date losses in local currency terms to more than 20%.  Both over the last quarter and the year-to-date, the UK stock market has been amongst the most resilient, thanks to its heavy weightings in energy and other multinational companies which benefit from a weak pound and also its low weighting (unlike the US) in highly valued growth stocks which have suffered most as bond yields have risen.  Looking ahead, we expect investors to become increasingly focussed on the outlook for corporate profits.  In portfolios which use actively managed funds, we continue to seek exposure to high quality companies with strong balance sheets and revenues that are likely to prove robust in any economic downturn.