There is no sugar-coating it; October was not a good month for investors. Headline indices sank across every major region and asset class, as global financial and economic conditions finally took in the central bankers’ ‘higher for longer’ mantra and started pricing in what that might mean for asset valuations over the foreseeable future. Economic indicators showed weakness across the developed world, but this was not the ‘good’ kind of bad news that, in the past would have made markets predict more dovish central banker pronouncements.
On the contrary, it finally became consensus that the US Federal Reserve (Fed) would keep interest rates high for the foreseeable future regardless – crushing historically high inflation but bringing asset returns down with it. This has been a slow-motion realisation, considering ‘higher for longer’ is effectively what the Fed and other central banks have been saying for over a year. It has clearly happened now, as last month’s table of returns shows.
In human terms, the most devastating story of the month was obviously the outbreak of the Israel-Hamas war. As horrible as the scenes are for anyone to watch, capital markets are not a moral barometer and so – for better or worse – global asset prices were relatively unmoved in the immediate aftermath of Hamas’ 7 October pogrom and what followed in reaction. In terms of the world economy, markets’ main worry is a broadening of the conflict to the wider Middle East and what this would do to commodity prices. It is perhaps unsurprising that the only meaningful positive returns in October came from gold and cryptocurrencies – so-called safe-haven asset for traditional and digitally-inclined savers. Tellingly, the Swiss franc (a safe-haven currency) rallied too.
Oil prices did spike in the wake of war, but have come back down since. Brent crude, the international oil benchmark, closed a peak of over $92 per barrel on 20 October, but finished the month a little over $87 per barrel, a 7.2% fall in sterling terms, despite numerous supply-side pressures. Along with the fighting, OPEC+ (including Russia) has been aggressively cutting production to push up prices. These had previously inflated Brent, leading to some concerns around renewed inflation pressures. As we wrote last month, oil inflation was never likely to create a sustained inflation push, since demand and spending power has weakened dramatically over the last year. Higher energy prices are more likely to act as a tax on consumers and non-energy businesses, hence reining-in activity. October’s petering out of oil’s rally supports this view.
In regional terms, October’s worst performers were the UK and Japan, with sterling returns of -3.7% and -3.9% respectively. The British economy is clearly seen to be in a weak position and interest rates are biting, evidenced by the news that mortgage approvals sank to their lowest level since January. Interestingly, this coincided with a surprise 0.9% increase in house prices for October which Nationwide attributes to a lack of properties for sale. Thankfully, shop price inflation sank to 5.2% last month, according to the British Retail Consortium. The Bank of England will maintain interest rates at their highest level in decades, though, as policymakers try to crush price pressures which remain elevated despite recent pullbacks as a result of a very tight labour market introducing second round price pressures.
European stocks were not much better off, shedding 3% in sterling terms. Again, the economy is weakening and this is clearly filtering through to inflation data. Headline eurozone inflation fell to 2.9% last month, below economist expectations and the lowest figure for more than two years. It came shortly after the European Central Bank (ECB) opted to keep interest rates static – a break from more than a year of consecutive hikes. ECB President Christine Lagarde nevertheless warned inflation will remain “too high for too long”, repeating the ‘higher for longer’ mantra being pushed by the Fed.
Just like in the US, European bonds have been under immense pressure recently. Borrowing costs for European governments are now the highest they have been since the Eurozone debt crisis of 2011 – when sharply higher bond yields threatened to destroy the single currency. That episode led to an incredible level of central bank support, but the ECB now has the opposite view. If inflation keeps falling – and lower than the 2% target is plausible in the coming months – the policymakers will come under pressure to soften their stance.
Fed Chair Jay Powell has proven himself the master of maintaining a tough stance this year. This is in large part because the US economy has shown a level of resilience that has surprised even the most bullish of investors in 2023. Americans’ willingness and ability to dip into pandemic-era savings – together with the significant fiscal stimulus the CO2 reduction investment subsidies introduced – has kept US businesses going strong and the labour market tight, despite myriad global economic headwinds. Stocks, meanwhile, had been predominantly boosted by the US mega-tech companies and the artificial intelligence investment craze behind them, paired with an enduring optimism that Powell and co will loosen policy sooner rather than later.
Optimism endures no more, it seems. US stocks lost 1.5% in sterling terms in October, while the tech-heavy Nasdaq fell 2.2%. These falls – along with the falls across most major regions – have been almost entirely a response to sharply higher bond yields, whose sell-off has been astonishing in recent months. Long-term US Treasuries touched their highest point in 16 years last week, briefly breaking above 5%. Disappointing quarterly earnings for some prominent companies only added fuel to the fire.
These losses should be put into perspective. Not only have they come after the sharpest monetary tightening in a generation across the developed world, but even after the falls, most major equity indices are up year-to-date. Only emerging markets (EM) – battered by weakness in China and adverse global financial conditions – are down among the major regions, losing 3% in sterling terms. With central banks now finally seeing the fruits of their labour, there is a good chance that we are at, or approaching, the real bottom for market sentiment. And if this is the worst of the cycle, it is a pretty mild cycle.
Asset class returns as at 31st October 2023
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The text is taken from The Tatton Weekly and is provided by Tatton Investment Management. The information in this document does not constitute investment advice or a recommendation for any product and investment decisions should not be made on the basis of it.
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