The economic headlines are almost relentlessly grim and for the most part getting worse. Markets are recovering. What on earth is going on? Answer: normal investor behaviour is being restored!
“Buy low, sell high”; it’s about the future with one eye on the past
That opening paragraph might seem counterintuitive and contradictory. But at the risk of pointing out the obvious (though it can never be said too often!), canny investors buy low and sell high rather than the other way around (the opposite is frighteningly easy to do: following the herd and running the risk of ‘chasing ambulances’, buying at the top and panicking at the bottom; it is the recipe for the old stock market joke: “How do you make a small fortune? Start with a big one! Ha! Ha! Ha!”).

Our regular readers will be familiar: markets use reported economic data as evidence of what has happened, a useful hard reference point but seen through the rear-view mirror. However, equity and bond prices habitually reflect what investors anticipate in the future, not what has already taken place (for the technically-minded, the price of an equity or bond is based on the prediction of future cash-flows attributable to the share or bond holder, discounted back to derive today’s net present value for the instrument after applying a risk-adjusted discount rate).
Recessionary pressures building…
This week saw the publication of a slew of economic indicators under the broad heading of Purchasing Managers’ Indices (PMIs). These are not official hard government data (such as that for reported GDP or the rate of inflation). Instead, the indices are a barometer of the business outlook as seen through the eyes of those involved in buying and selling goods and services. Polled monthly, business managers are asked their perceptions on the future trends in order books, input costs including raw materials and wages, the supply and demand for labour in their industry and geography, trends in selling prices, the outlook for profit margins etc. The data is collated and compiled into an index; a nominal index value above 50 indicates business confidence and economic expansion; conversely, a figure below 50 indicates a recessionary outlook, the economic equivalent to Eeyore’s boggy place: gloomy and sad and full of thistles. While useful indicators, PMIs come with a health-warning: although supported by empirical data, they contain a large element of ‘finger-in-the air’ assessment; confidence is intangible and ephemeral and can evaporate as fast as it grows.

With that in mind, the US Manufacturing PMI for November was reported at 47.6, down from 50.4 in October and well below market estimates. It is the first monthly recording for the US in sub-50 recessionary territory since the big collapse in confidence in Lockdown 1 in the first quarter of 2020 when the index plummeted into the 30s. To be fair, the index value has been steadily declining from nearly the mid-60s a year ago; the difference this time was that crossing of the magic ‘50’ barrier. The US Non-Manufacturing Business Activity Index was still positive at 55.7, though it fell from 59.1. In Germany, the November figures for manufacturing and services were 46.7 and 46.4 respectively (the manufacturing number improved slightly from 45.1). Here in the UK, our PMIs recorded 46.2 in the manufacturing sector and 48.8 in services.
…from which markets detect a softening if not a full reversal by central banks
Stepping back from the detail: essentially economic activity is slowing virtually everywhere in the West; global oil prices have been weakening; the US rate of inflation is falling. The inference is that the central bank monetary medicine is working. That view was officially corroborated this week on both sides of the Atlantic. In the US, the minutes of the Federal Reserve’s November policy meeting were published, in which it was revealed that while in November an interest rate rise of three-quarters of a point to 4% was merited, there was unanimity that all other things being equal, December’s rate rise should be limited to a half point. The Fed’s current intention is still to pursue rate rises, more slowly than hitherto, but possibly for longer (on that score, particularly in the context of what is expected to be the terminal or peak rate, the markets and the Fed are still engaged in a game of bluff). In the UK, the Bank of England Chief Economist Huw Pill indicated that our own December interest rate rise might also be toned down from the three-quarter point deployed most recently. As central bank policy becomes less aggressive, so the greater likelihood of seeing the resumption of growth in the foreseeable future.

Earlier this year, when the Fed deployed its first interest rate rise of a half-point instead of the usual quarter-point, the financial headlines were hyperbolic in their reaction to ‘unprecedented’ policy aggression (unusual, certainly, but not in fact unprecedented). Half points were quickly superseded by three-quarter points (even the use of a full point at one sitting in Canada); and yet now markets are all a-twitter at the prospect of a resumption of half-point increments representing some major reversal in policy, some even referring to it as a ‘pivot’. It is no such thing: the Fed will still be employing quantitative tightening, merely with slightly less vim and vigour than in the past couple of months, but still twice as aggressively than at any point in the last three decades. It is all a matter of perspective and proportion!
Bond yields are subsiding after a frenetic period
It is worth noting the sea-change in perceptions from only little more than a month ago when markets were distinctly febrile. From their most recent peaks in the second half of October, global sovereign bond yields representing those governments’ borrowing costs have been retracing their steps: the US 10-Year Treasury at 3.7% is down more than 0.6 of a percentage point (or in market-speak, 60 basis points, there being 100 basis points in a percentage point); Germany’s 10-Year Bund yield is back below 2% at 1.90%, 55 basis points from its peak. The UK 10-Year Gilt has fallen even more substantially: from a peak of 4.51% when there was maximum panic about mortgage rates, it is now 3.07%, a point-and-a-half lower; ironically the last time it was this level was September 5th, the day that Liz Truss entered No 10. These falling yields represent rising (or more accurately recovering) bond prices. All major bond yields are significantly higher and prices are still correspondingly lower than they were at the start of the year (investors in the UK ‘Long’ 15-Year Gilt had seen the value of their investment very nearly halve in the 10 months to mid-October; after the recent rally that drawdown has been reduced to merely a third!).

The market’s interrogation of the chicken’s entrails, particularly regarding the Federal Reserve’s policy, has produced another effect: a weakening of the US dollar (If you Google ‘DXY’ you will find several websites which chart the fortunes of the dollar trade-weighted index against a basket of currencies including the pound, yen and euro). ‘DXY’ began the year at 96, the dollar subsequently appreciating by 18 percentage points to 114 at the end of September, since when it has retreated to 106 today. Despite a prolonged period of dollar strength going all the way back to 2008 (when the index was 72) and still being close to post-Global Financial Crisis highs, the dollar has plenty of supporters even if there is short-term weakness: the US is the world’s dominant economy at 25% of global GDP; its economic fortunes rely far less on international trade than any other major competitor; the country has very little reliance on others for energy; and the dollar remains the world’s most significant reserve currency, however much others including China and Russia have a long-term strategic aim to disintermediate it.

In sterling terms, on the other side of that trade and helped by market relief that the brief experiment with ‘Trussonomics’ and the brutal reaction to it are dead and buried, what a reversal of fortunes! If after the paroxysms of the post-Kwarteng ‘fiscal event’ and the predictions of our sinking to parity with the dollar, from a historic low of $1.07 on 27 September, sterling has recovered to $1.21 today, a rate last seen on August 12th (however, before we get too excited, in context it was $1.33 at the beginning of the year and reached a 2022 peak of $1.37 in January). For a nation which is a significant net-importer, that strengthening of sterling helps relieve some inflationary pressure on imported goods (on the other hand, it makes our exports more expensive and less competitive).
Return of a ‘bull market’ or a ‘bear trap’?
Markets tend to like a strong end to the year and to find reasons to see it happens (sometimes it does not work, as in 2018 when equity markets dropped by a quarter in December). If not before the year-end, what can frustrate investor’s restored optimism? One is another global exogenous shock yet to make itself known: it is not easy to legislate for the mayhem any of the Four Horsemen of the Apocalypse may unleash as we know only too well in the past three years from Covid and Putin. On the economic front, inflation may prove more enduring than assumed, however, that will only become apparent during the course of 2023 and in to 2024; an important factor in the duration and stickiness of inflation will be labour rates and here in the UK it is clear that the public sector unions ranging from education to transport and health are all intent on industrial action over the coming months in pursuit of higher wage claims. Finally, there is the risk we talk ourselves into a much deeper recession than need be the case. Central banks seem more aware of this risk but are still minded that inflation is the greater, more insidious enemy than recession.

This year, most of the damage done to equities was due to a rating compression: investors were prepared to pay less for high-performing companies whose growth prospects were loaded further into the future (especially in sectors such as technology). Were it to happen, a deeper than expected recession would put pressure on companies’ earnings, dragging down the share prices of the more economically vulnerable.

Against this backdrop, as an investor it pays to have a diversified portfolio encompassing different asset classes, a variety of geographic exposures and not being wedded to a single investment style. And above all, to keep an open mind. Whether accurately attributed to Winston Churchill or John Maynard-Keynes, it matters little, the wisdom is enduring: “when the facts change, I change my mind. What do you do?”

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

The value of active minds – independent thinking

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Fund specific risks

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