Following the release of growth figures in the UK below expectations and this week seeing the odds of the Federal Reserve cutting rates in December move back and forth between 60% and 80%, James Klempster discusses how to manage portfolios amid the louder noise.
Hello, it's Friday 15th November. I thought we'd pause for a few moments and reflect on what's been going on in markets this week. We're midway through November so let's see what's been going on in equity markets. We've got the US market up mid-single digits and doing fairly well over the course of the month. Whereas the likes of Europe and the UK are flat to down in sterling terms, depending on exactly which market you look at.
In year-to-date the differential remains – the US is up around about 25%, up a quarter in its value in sterling terms this year so far, year-to-date. The UK is up 4%- 5% in sterling terms. Europe's is only up around 2% and it really does depend on which market you look at to see how it is getting on. France is actually down year-to-date in sterling terms, whereas Germany's up. And again, it just demonstrates how a one-size-fits-all approach to these markets isn't necessarily going to work where we're going from here and we'll talk about in a moment. Asian emerging markets are also up over the course of the year so Europe really is the weakest spot out there in the year-to-date.
UK growth figures – and US rates
Today we've had UK growth data out for the third quarter. It was a little bit disappointing, up 0.1% over that three-month period. It disappointed on two levels I suppose. The first one being compared to expectations which were up to 0.2% – so we saw half the rate of growth compared to what was expected over the third quarter. And the previous quarter, the second quarter of the year, we had growth of 0.5%. So again, a bit of a differential there and understandably the news hasn't been greeted particularly well. We also had inflation data out of the States this week and it's demonstrating a degree of stickiness that makes predicting what the Federal Reserve is going to do a little more challenging.
We've actually seen the probability of a December rate cut dance all over the place this week. There was about a 60% probability of a rate cut being expected at the start of the week. That jumped to about 80% probability of a December rate cut in the middle of the week and now it's back down to 60% again, following some comments from Jay Powell. If you're relying on these very fickle data series, you can easily get caught out. They move very quickly and you can easily be on the wrong side of them.
Inflation and fragmentation
Taking a step back, it's not a particular surprise that we're seeing these inflation numbers be a little bit stickier, for the reasons we've gone into in previous videos. I think we need some context as well. The rate of inflation that we saw in October annualises, if you're to annualise, it's always a dangerous thing annualising one month's data over 12 months. But if you annualise the inflation number, it sits somewhere between 2% and 3%. So it's ahead of target clearly, but not massively ahead of target and certainly not in this higher inflationary camp that we became accustomed to a couple of years ago. It's very much in the range of where we think inflation is likely to settle for the foreseeable future. There are lots of reasons why that's the case, not least the fragmentation of globalisation and the inefficiencies that will bring in. There are additional challenges in the US, of course, coming from the expectation that Donald Trump's policies will likely be inflationary. Things like tariffs and things such as being much harsher on immigration tend to be, or at least are expected to be, inflationary in the short to medium term. Catherine Mann of the Bank of England made comments along those lines this week as well, suggesting that the fragmentation of globalisation will put pressure on consumers and prices. And so it’s a nice reminder of the features that we expect to see in the environment going forward from here. More inflationary, not necessarily elevated levels of inflation, but certainly higher than that which we've become accustomed to in that period between the financial crisis and that Covid period a few years ago now.
The picture for bonds
The government bond markets have responded to that. US and UK 10 year yields are in the 4.5% levels – reasonably attractive yield levels from these bonds. You're getting some sort of real yield from them, you're getting paid to hold them – paid to wait, if you like. And of course, because yields are higher, you do get the chance of capital appreciation as yields come down, as risk aversion increases. Yields tend to come down when risk aversion goes up. From a portfolio construction perspective for us as multi-asset investors, that's actually quite a neat facility. And it's much more in line with what you'd expect bonds to do over the long run. They've had a period between Covid and the financial crisis where their role was much more capital orientated because yields became so low. But now they can fulfil their traditional portfolio role of providing income and diversification because they have that ability to have the yields come down and their price to go up.
On the subject of market moves and risk aversion and noise; one thing we need to bear in mind, seeing the president-elect start to build his team, it does look like the sort of team that will provide plenty of noise on the way. This is not necessarily problematic, but it’s worth bearing in mind when thinking about building portfolios and managing investment for the long-term. What we want to really be is a noise suppressor – looking through some of that noise to identify signals, the fundamentals, which we believe will be more rewarding over the medium to long term and to build portfolios around those, rather than trying to chase our tail and jump around. Just look for example, at the probabilities of expectations of interest rate cuts in the US over the course of this week to show how difficult and indeed how potentially dangerous getting on the wrong side of those sorts of trades can be. That's it from me. Have a good weekend when you get there and we'll see you next time.
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