The week in review

What’s happened in markets?

In the US, the Institute for Supply Management’s (ISM) measure of manufacturing activity came in below expectations at 50.9 for September. Levels under 50 indicate contraction and it was the index’s lowest reading since May 2020. However, the ISM services index came in above expectations at 56.7 (56.0 expected) with the employment component at a six-month high. US employers added 263,000 jobs in September according to the nonfarm payrolls data, while unemployment fell to 3.5% from 3.7% in August. These signs of ongoing tightness in the labour market meant inflationary pressures continued to weigh on the economy. The consensus from the Federal Reserve (Fed) over the week was particularly hawkish with multiple speakers dispelling the expectations of interest rate cuts in 2023 that the market had started to factor in.

Political developments remained the focus in the UK following the market turmoil triggered by the new government’s mini-budget. Fitch Ratings revised the country’s credit outlook to negative, stating the inconsistency between fiscal and monetary policy given strong inflationary pressures had, in its view, negatively impacted market confidence. This followed a similar move by Standard & Poor’s on 30 September.

In the EU, the minutes from the European Central Bank’s September monetary policy meeting showed increasing concerns about persistent high inflation and support for further aggressive interest rate rises, despite recessionary fears.

In company news, Samsung Electronics announced its preliminary earnings for the third quarter were forecast to be below expectations. Advanced Micro Devices, an American multinational semiconductor company, also conveyed a revenue warning due to weaker PC demand and supply chain issues.

Global inflation fears intensified as the OPEC+ oil alliance agreed to cut output by two million barrels per day to stabilise oil prices, which had seen falls in recent months as the world economy slowed. The news was not well received by the US. The price of a barrel of Brent crude jumped to more than US$93 on 5 October after the announcement, adding further inflationary pressure at a time when much of the world is battling rising energy costs.

Despite the insistence of central bank speakers, the market still has doubts over their rigour in the face of weakening economies. This led to a broad-based rally at the start of October, curbing some of the losses seen in September, and left little to distinguish between style, market capitalisation and region over the last 30 days. Emerging markets (-6.0%) continued to perform slightly better than developed markets (-7.4%) over the short term, but still lagged over the longer term. In terms of style, value (-6.2%) continued to outperform growth (-8.2%), while small capitalisation stocks (-6.4%) beat large capitalisation stocks (-7.1%). The best performing sector was energy (+2.9%) following the OPEC+ decision to cut global production, while real estate (-15.0%) retained the worst performer title over the last 30 days.

After their recent volatility, bond yields were back on the rise and short duration government bonds continued to outperform, with 1-3 year bonds dropping -1.1%, against -3.2% for 7-10 year bonds.

Following the recent shock of the UK mini-budget, sterling recovered against the US dollar, although it was still down over the last 30 days.

What’s happened in portfolios?

While it remains a challenged environment for equities with clear headwinds present, we continue to tilt our equity positioning towards the US and quality growth strategies, which we believe will perform well in a recessionary environment and provide some protection on a relative basis. We have also increased the resilience of portfolios by trimming cyclicality. During the week of 3 October, we sold out of the iShares FTSE 100 ETF given the outlook for UK assets, which do not look strong as inflation concerns and fiscal policy drive sentiment for the UK much lower. We also locked in some of our profits from Dodge and Cox Global Stock Fund, which has benefitted from its overweight to financials and energy. These trades mean we now have a stronger bias to quality which is coming from our defensive large capitalisation managers.

Fixed income has become more attractive following the significant upward shift in yields. We’ve increased our total exposure to the asset class by reducing our more speculative exposure to high yields and increasing duration by adding to government bonds at the longer end. We’ve also added further to the Treasury Inflation-Protected Securities (TIPS) within the portfolios to give some inflation and broader stagflation protection. Our focus remains on the US and Treasury markets, as well as broader global bond markets, where we have seen rates at the longer end increasing with yields going up, which we have been buying into.

Real assets remain attractive as an alternative to fixed income with some inflation protection. We have been increasing our exposures to areas such as infrastructure and music royalties which offer a high level of diversification in this challenging environment. In particular, 3i infrastructure has continued to perform robustly and ahead of expectations. The company expects to report growth ahead of target and will benefit from the fact no material refinancing is required in the portfolio until 2026, so should not be impacted by the increase in borrowing costs.

In terms of our alternative strategies, Princess Private Equity released a 0.3% increase in its net asset value for August.

Cash is becoming more attractive given market volatility and increased interest rates. We currently have a slight overweight to cash while we wait to redeploy it as market opportunities arise.

What’s happening this week?

12 October • UK Gross Domestic Product | 12 October • EU Industrial Production | 13 October • US Consumer Price Index