Calm returns to markets
November saw good recoveries in bond and equity markets, further to the turmoil earlier in the autumn caused by rapid rise in interest rates on concern over soaring inflation.
Every economic data point is being analysed to provide clues on the outlook for inflation and the likely peak in monetary policy. In the US, the Federal Reserve raised interest rates by 0.75% with hawkish comments that there is “some way to go” before pausing; markets currently expect rates to peak at over 5%, with no cuts until the second half of 2023. Here in the UK, the Bank of England also raised interest rates by 0.75% to 3% and continued to provide a downbeat assessment on the UK economy in terms of rising unemployment and falling business investment. This feels too pessimistic based on the feedback we are receiving from fund managers and companies we talk with – many companies are trying to find and retain staff rather than lay them off.
Soaring global energy prices have been a big driver of recent inflation, but with demand down around 30% and storage above trend the net result has been a sharp fall in oil and gas prices. This will help bring down inflation as energy remains a significant component of the current 11.1% CPI inflation seen in the UK.
UK equities remain attractive
Turning away from the economy to equity markets, third quarter results from UK companies have generally supported the earnings picture. Results from the Energy and Financial sectors reassure us that both sectors are undervalued. The UK oil majors are significantly more profitable than a decade ago when oil prices were at similar levels. Disciplined capital expenditure and strong balance sheets continue to support attractive dividends and share buybacks.
UK equities continue to trade on attractive valuations, with the 12 month forward price / earnings on 9.3x. However, we are mindful that many earnings will weaken over coming quarters as we go through recession and due to the impact of corporation tax changes.
Reasons for optimism
The clouds of uncertainty around global geopolitics remain. However, some of the clouds over the UK have started to lift, with greater stability following the change in leadership and reversal of most of the mini-budget decisions bringing calm to the bond markets. This is an important precursor before we see an improvement in risk appetite towards UK equities. In addition, we should see inflation start falling into the first half of next year and markets will start pricing in at least a pause in the tightening of monetary policy. This should lead to a rise in investor confidence.
Subject to the conflict in Ukraine not worsening over coming months, the peak in inflation and in turn interest rates remain the most likely catalysts for sentiment to improve, and when it does the response from equity markets could be swift, hence we remain overweight equities.
Important Information
This article is for information only and does not constitute advice or recommendation and you should not make any investment decisions based on it. The views and opinions of this article are those of Casterbridge at the time of writing and may change without notice. Any opinions should not be viewed as indicating any guarantee of return from investments managed by Casterbridge nor as advice of any nature. It is important to remember that past performance and the value of an investment, and any income from it, may go down as well as up and the investor may not get back the original amount invested.
