Key Charts
Here are some key charts showing what has been going on in investment markets of late, with our views on what we think will happen next.
Base Interest Rates
This week saw the Federal Reserve cut 0.5% off base interest rates in the US. This was the first cut in over 4 years, after having been cut to zero during the Covid years before being ramped rapidly to over 5% to fight post Covid inflation.
This was a much-anticipated move, and more cuts are expected. The speed of cuts will depend on how strong the US economy is from here. Steep cuts may come if there is a deep recession, but we expect more gradual cuts with a reasonably soft landing.
Currencies
The Bank of England pre-empted the Fed by moving base rates down 0.25% a few weeks ago but held rates this week. UK service sector inflation is still over 5% and the labour market stronger than in the US. This has seen the pound strengthening against the dollar. If we look elsewhere it seems to be more about the dollar weakening rather than a hugely strong pound.
Over the last 2 years we have seen a strong GBP/USD exchange rate move approaching a 30% appreciation for Sterling as can be seen below:
Amazingly (unless you read the UK tabloids or look at social media) the UK is standing out as a reasonably stable country. A new Government has been elected with a strong majority and achieved without an assassination attempt!
The November budget will be the next test for the Pound, if it looks sensible this trend could continue. Calling currency movements is notoriously difficult, but for now the trend of tail winds for overseas investments which had been strong until the end of 2022 is over. UK investors in equity indices dominated by US equities have lost 4.5% so far this year down to currency movements.
Sterling is still well below its long term, pre financial crisis level of more than $1.50 to £1.
UK Bond Yields
The UK yield curve continues to normalise with higher long-term yields looking here to stay despite base interest rates coming down.
Here is the history of 10-year Government bond yields in the UK.
Rates around 5% for 10-year gilts would be very normal even with inflation at or around 2%. At the turn of the century inflation had already fallen to around 2%-3% and these rates were over 5%. Without Quantitative Easing (QE) artificially depressing bond rates, we expect them to remain elevated in the range of 4-6%.
Here is the current yield curve on UK gilts and from 6 months ago showing interest rates for increasing terms (left to right) and with the 6 month change underneath in bars. The cut in base rates was very much anticipated and if anything, bond yields rose slightly this week.
The main movement here has been at the ‘short term’ end where sub 5-year bond prices have risen strongly, and yields have been falling. Longer term rates are much more stable and remaining elevated. Short term Gilts bought 18 months ago have delivered fantastic tax efficient returns but returns from here will be significantly lower.
As base rates fall, we expect the very short end to fall with it, but we think longer term rates may even rise a bit from here, if inflation proves stubborn.
Equities V Fixed Income
With much higher and stable longer term bond rates our fixed income managers are making hay.
Here is our high yield portfolio versus the average global equity fund over the last 2 years.
Equities
The picture in equities is quite mixed. On a big picture basis, the post ‘Great Financial Crisis’ rally is getting old and valuations of the biggest companies dominating US and world equity market indices are relatively high.
The main market weighted US S&P 500 index, the constituents of which dominate world indices, has risen around 8-fold since 2010. It is equivalent to roughly a 16% p.a. compound return.
Make no mistake, this is not a sustainable return for the future. Long term history suggests that equities return around 6-8% above inflation and US inflation since 2010 has averaged around 3% since 2010. So even taking the top end of this range, US equities could easily be 50% overvalued. They were probably undervalued in 2010, but you get my point.
In the words of Warren Buffet, if things can’t keep going up for ever, they won’t. We are probably getting into this territory with some of the big mega cap US companies that dominate US and world indices. Their valuations are likely to fall, or perhaps just stall, for a few years whilst profits catch up. Any major downturn in investor bullishness on equities could be messy and Warren and Berkshire Hathaway have been taking profits and holding cash – we should all take note of this.
As can be seen in the fixed income vs equities chart above, the average global equity fund has pretty much levelled-out since April this year, but this is not the case for all equities.
If we look at our asset backed equity funds in infrastructure and real estate for the last 6 months we see a different picture.
We are also seeing signs of growth in our small and mid-cap funds and in areas of the stock market away from the US mega cap tech stocks.
This feature of a wider recovery in under loved sectors and stalling in the values of the biggest tech companies is also becoming apparent in US equities. If we look at the S&P 500 based on equal weighting i.e. the same amount in each company rather than based on market capitalisation, we can see that since mid-July the rest of the S&P 500 index companies have been performing more strongly that the biggest companies.
That is enough charts for one update and apologies for anyone who prefers to read and not look at charts, I always find the charts more compelling!
In summary:
- We don’t see much to worry about in base rates coming down, it’s much anticipated and UK house buyers will be pleased as mortgage rates soften.
- We continue to be impressed by our fixed income funds returns and expect it to continue.
- We see risks to falls, or simply lower returns in market cap indices such as the S&P 500, the Nasdaq and the World index all with currency headwinds.
- We like our diversified active fund managers in equities investing away from the indices.
The Autumn Budget
We are seeing the imminent Budget stirring people to look at their investments, this is generally good news. It is always good to take stock, and inertia is strong when it comes to money, so it is good to have a catalyst for thinking about changes.
The key discussion areas are pensions, capital gains and inheritance tax.
- Will tax relief on pension contributions be reduced?
- Will the pension tax free cash sum get reduced?
- Will capital gains tax go up?
- Will the ability to offset past losses against future gains be removed?
- Will our ability to make unlimited lifetime gifts without liability to IHT assuming we survive them by 7 years be broken?
We will have to wait and see. Our strong advice is to consider where these things impact you and speak to our advisers. In every question there are actions that can be taken in the next few weeks to mitigate risks, but don’t leave it too late. We published a piece on this very topic this week on the Tideway website. If you are interested in understanding more about what you could do, you can read it here.
If you have colleagues asking about these issues over the dinner table or in the pub, we would be delighted to help!
The content of this document is for information purposes only and should not be construed as financial advice.
Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise.
Any rates of tax referred to are correct as at the date of this document and there are no guarantees of what changes these may be subject to in the future.
