Economic background
It looks like long upward economic cycle we have experienced is losing strength. Given the amount of monetary tightening that the Bank of England, the Federal Reserve, and other central banks in developed countries have been doing for almost a year and a half, some slowdown is generally expected. While the threat of high inflation seems to have eased, the likelihood of a mild recession in the UK, Europe and the US has increased as the year has progressed.
By examining how interest rates have peaked in the past, as well as how quickly they typically fall, we note that we will likely hit a peak in interest rates as inflation continues to decline in line with the falling price of oil. Economic activity, however, has been holding up better than many had feared.
Market background
Equity markets have recovered some of their lost ground despite the recent market turmoil. While there were severe banking issues at institutions like Silicon Valley Bank and First Republic Bank in the US and Credit Suisse in Switzerland, their problems have been tackled by central banks. If there is further credit tightening to come and money flows become unsettled, markets could remain choppy in the months to come.
However, lending is expected to continue at a reasonable pace as the demand is still present. This is important for valuations in equity markets.
Economic outlook
Central banks must balance financial stability and inflation control. There are positive signs that labour markets are showing resilience, though inflation has been stubborn to ease. These key factors should be watched as tighter monetary conditions work through the economy.
Market valuations
Higher mortgage rates have damaged home sales. Other warning signs, such as weakening business confidence, delaying long term investment plans and consumers’ using up savings have negative impacts on the prices that investors are willing to pay for income and growth. The relative attractiveness of bonds and cash has improved as interest rates have risen over the last 18 months.
Multi-Asset Strategies
For equities, markets in the UK, Europe, US, and Asia have been moving upward and, in some instances, risen to or near their 2021 peaks. Valuations may be higher than normal on a short-term basis as some company profit forecasts have not fully reflected the chances of even a modest recession. However, the longer time horizon suggests the overall return of stocks will be greater than fixed-income assets over the coming decade.
For government bonds, the interest rate levels are attractive again and decent income can be earned from high-quality bonds.
Across the world, wage gains, though rapid in some places, have not kept pace with inflation. In fact, out of 186 countries, more than 75% of them have inflation over 5%. This is a global erasure of buying power and it reduces the demand for goods and services.
As signs of a slowdown become clearer, the US Federal Reserve, the Bank of England and other central banks will be likely to cut interest rates. This type of policy change would set up an attractive platform for both equities and bonds going forward.
How can we help?
Our financial advisers are here to help you navigate the current market conditions, and support you to make smart investment decisions. To find out more visit our wealth management pages, or contact Richard Basford directly, at richard.basford@nfp.co.uk