Quarterly investment outlook - Q4 2023

To continue the trend from previous quarters’ comments, and to no one’s great surprise, interest rate policy and central banks’ commitment to taming inflation is still the biggest single factor driving investment markets. There has though been a noticeable change in messaging from central bankers with indications being that we are at or near the end of interest rate rises, but that there is an expectation that rates will stay ‘higher for longer. The ‘higher’ part is probably easy to divine, i.e. rates will be broadly where they are now, but the ‘longer’ element is much more difficult, and by the Fed’s admission will be ‘data dependent’. Predictions for when interest rates might be cut again are continually pushed back as economies show some resilience, but cuts are still expected next year. Our thoughts are that if they can, monetary authorities would have a strong preference for maintaining rates at current levels for longer than the market expects, and at levels that they consider to be more ‘normal’ by historical standards.

The decision to end the rate hike cycle can be attributed to two closely related factors; significant falls in headline inflation rates, and signs that the global economy is slowing. The mathematical construct of inflation statistics meant that inflation was bound to fall quickly as the dramatic increases experienced last year fell out of the calculation, with more recent price rise data being much more benign. That said, whilst headline numbers have come down quickly, core inflation (which excludes the more volatile elements of energy and food) is reducing at a much shallower trajectory and remains above target. Falling housing costs should continue to feed through in US inflation, but we doubt that victory over inflation can be declared just yet.

From an economic perspective, there are plenty of reasons to be pessimistic. The US economy in particular has indeed remained reasonably resilient, helped by the fact that unemployment remains very low and fiscal spending is still profligate, but neither is guaranteed to continue particularly with the recent events in the US Congress. Globally, purchasing manager indices (surveys of companies and their future expectations) signal that economic activity is slowing (more so in manufacturing), a picture not helped by increasing restrictions on global trade brought about by geo-political factors. These indicators suggest that the effect of interest rate rises is feeding through into the economy as financial conditions become much tighter than they have been for some time. In simple terms, the cost of finance for households, companies, and governments has increased sufficiently to reduce demand, and we expect this situation to persist not least due to the amount of debt which the US Government has to refinance over the next three years. Finally, the amount of excess savings which households built up during the pandemic looks to be at or close to depletion, an assertion backed up by increasing credit card delinquencies and not helped by the ending of the moratorium on student loan repayments in the US.

At our September meeting, the Investment Committee voted to maintain our defensive position within fixed income through our shorter duration position and limited exposure to lower quality bonds and to continue to limit exposure to the higher valued tech sector. In line with our new strategic asset allocation, we introduced energy equities to the portfolios to protect against the inflationary impact of higher energy prices.

David Baker, Chief Investment Officer

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