Reflections of the CIO...

In September, we had written about how the shift to a pro-growth stance by the majority of the world’s central banks was an important change for the market environment going forward. This shift manifested itself in the form of interest rate cuts in the West and in a wide-ranging stimulus package in China, with both actions combining to provide a strong boost to medium term growth prospects and consequently equity markets. At the same time, many other factors which shape the investment environment did not change at all, particularly the issue of investors short term focus on economic data releases or political events, a feature which exerted its influence throughout October. Market sentiment waxed and waned, particularly in bond markets, as the implications of US and UK government policy began to coalesce ahead of the UK budget and the US election.

In the end, the impact of the UK budget on UK assets was difficult to separate from broader global market trends, particularly the weakening of bond markets worldwide. This decline in bond prices was driven in part by growing concerns over the potential implications of the upcoming US election, which had captured renewed attention in the markets. Many developed market government balance sheets are not in good shape, mostly as a result of government largesse during the Covid pandemic. By effectively socialising the losses of households and corporations during this difficult period, Western governments stretched their balance sheets to the limit, making any tax or spending decisions from then on much more impactful than usual.

Whatever the outcome of the US election (and at the time of writing we do not know what that will be) neither candidate had discussed the need for restraint on spending. Subsequently, bond markets spent a lot of October on the back foot as they factored in the increased risks of the US debt binge extending under a new administration. The UK faced a similar situation with a long awaited budget finally delivering on the increased tax and spending package, which had been so heavily trailed before.

Faced with the prospect of more borrowing coming down the line from UK and US governments, bond markets began to sell off and ended up giving back nearly all their recent gains. Equity markets initially began October in an optimistic mood, as good current earnings and the improving growth outlook buoyed sentiment, but this mood soured by month end, dragged down by a government bond market which was under considerable pressure. The oil price added to the general pick up in volatility, waxing and waning between $71 and 81 dollars, driven again by the political tension in the Middle East.

Overall, we would describe October as a month during which markets ‘found it hard to get their story straight’. Although the big trends are becoming easier to discern – good growth, steady to falling inflation, and falling interest rates – there was also a sense that predominantly in respect of the US election, was an event which could be very impactful, but which was also extremely difficult to price in advance. Cue nervousness.

As we have previously written, we think we are ‘almost there’ in terms of arriving in a new normal investment world of higher inflation and higher interest rates, but which also is less prone to the violent swings of the last few years. The last hurdles to cross are the political events of late October and early November and whilst they have the capacity to cause a spike in volatility, any unrest in markets will act as a discipline on government policy (we have our own ‘Liz Truss’ moment as evidence of that). Checks and balances exist not only in constitutions but also in investment markets, where ultimately governments who need to borrow to enact their mandates will end up having to prune their wilder promises if they want the money at an acceptable price. That thought provides some comfort as we head into the final months of an eventful year.