Market update: October 2022
- Shunil Roy-Chaudhuri
- 20 October 2022
- 10 mins reading time
On October 18, we hosted a webinar in which we assessed high inflation, political developments in the UK, the continuing tragic conflict in Ukraine, and the outlook for the months ahead. We also looked at our current investment positioning. This briefing is based on that content.
We are in challenging times. In the US, inflation stood at 8.2 per cent in September, while in the UK it hit 10.1 per cent. And new UK chancellor Jeremy Hunt, the fourth chancellor in four months, reversed many of the policies made in the mini budget just three weeks previously.
Despite Mr Hunt’s new policies, a budgetary shortfall of up to £40 billion remains (1). This suggests cuts will have to be made to public services. Thankfully, the markets responded positively to Mr Hunt’s policies, with a rise in the value of sterling against the US dollar and a rise in the prices of UK government bonds.
Even so, sterling has been weak against the dollar this year, falling from a value of $1.35 at the start of 2022 to $1.13 at the time of writing. This is partly because the US dollar becomes favoured by investors in difficult economic times. But it is worth noting that, at Schroders Personal Wealth (SPW), we are global investors: our medium-risk “Balanced” portfolio, for example, contains only 12 per cent UK shares (equities). Moreover a weak pound can cushion declines in the value of overseas assets.
The markets have so far had a tough 2022. With the exception of commodities, all the main asset classes have fallen, with US shares, global government bonds and global bonds from companies all down by more than 20 per cent (2).
In sterling terms, however, the declines have been more muted (see Chart 1) while the performance of commodities have been extremely strong. So a weaker pound can benefit overseas investments once their performance is calculated in sterling terms.
Chart 1: The weak pound cushions market declines and boosts commodities in 2022
Source: FactSet asset class returns 31/12/2021 to 13/10/2022 in sterling terms.
Moreover, international UK companies can also benefit from a weaker pound. Indeed around 75 per cent of earnings from the 100 largest UK companies comes from overseas.
Markets overall have been weak in 2022, but they have generally been stronger over the past five years (see Chart 2). We would like to point out that, at SPW, we work to an ongoing investment time horizon of at least five years. But we do keep a keen eye on short-term market movements and invest appropriately if we believe there is an opportunity.
US shares (equities) have been a standout performer in the past five years, rising by 81 per cent. In recent years, we have reduced our exposure to UK assets and increased exposure to overseas assets. We believe equity growth in the next three to five years will come from overseas markets.
Chart 2: Overall market performance is stronger over five years, even in local currency terms
Source: FactSet Asset class returns 13/10/17 to 13/10/22 in local currency terms.
As mentioned at the start of this article, inflation is currently at high levels. High inflation in the US, UK and Europe is mainly driven by two factors. First, the tragic events in Ukraine have led to a rise in the prices of oil, gas and wheat, as Russia is a large energy supplier and Ukraine a large wheat producer. Second, the impact of Covid-19 lockdowns resulted in a contraction in the production and transportation of goods. This created a scarcity of some goods that led to a rise in the prices of many items and fuelled inflation. And we expect inflation to remain high in 2023.
High inflation has driven central banks to raise interest rates. This increases the cost of borrowing, which can potentially reduce demand for goods and services within the economy (as people have lower disposable income) and so can help bring inflation down. For 2023, we expect UK interest rates to rise to 4.5-5 per cent, US interest rates to rise to 4.25-4.5 per cent and European rates to go up to around 3 per cent. Central banks, such as the Federal Reserve in the US and the Bank of England in the UK, are typically wary of raising rates too quickly as this could hinder economic growth.
On this basis, we believe central banks could potentially begin to reduce interest rates after 2023 should inflation begin to fall. And there are some indications that oil and food prices could potentially be beginning to fall, with recent declines in the price of oil and food (2).
Altering our investment outlook
During the course of the year, as the tragic events in Ukraine deepened, we made some significant changes to our outlook. Most notably, we moved from a positive view of shares to a cautious one and, in contrast, from a cautious view of cash to a positive one. We currently hold around 5 per cent cash in our Balanced portfolio. But we should point out we retain our mix of different types of assets and are just making relatively small changes to our allocations.
We are currently cautious on fixed income assets, namely government bonds and bonds from companies. But we believe there could be potential opportunities in bonds from emerging market governments.
We also think there could be potential opportunities for equities in China and emerging markets. Covid cases shot dramatically upwards in China between March and May this year, but subsequently declined dramatically. China is now cutting interest rates and spending on infrastructure, suggesting it could potentially be a driver of global economic growth.
Moreover, we believe US equities overall could potentially withstand a slowdown in economic growth better than equities in other countries. This is because, in our view, it contains financially strong companies with good growth prospects that could potentially do well in the start of a slowdown.
We are keeping a close eye for indications that economic conditions might be improving and will move some of the cash back into other assets if we believe there are potential opportunities.
Higher income from bonds
There is no doubt that 2022 has been tough for bond investors. But we are now seeing higher yields in bonds from governments and companies (bond yields go up when bond prices fall). So we believe there could now be potential investment opportunities in these assets. We note that bond prices fell in 2008 only to rise in 2009 (5). If interest rates do not rise by as much as markets expect them to, then we believe bonds prices could potentially rise from current levels.
Turning to equities, we highlight the fact that the top 500 US companies have collectively made average returns of 11 per cent a year during the past ten years. In addition, since 1980, annual overall returns on these companies were positive in 32 out of 42 years (4). Furthermore, the average ratio of share price to annual earnings (per share) for these companies now stands at 15.3:1, below its 30-year average of 16.2:1. In our view, this suggests US shares could potentially be an investment opportunity.
In the end, though, economies and stock markets do go through cycles. Trying to time these cycles is very difficult, which is why we say investing is about time spent in the markets rather than timing the markets. We believe there is a risk of missing out on investment opportunities if you sell at the wrong time.
Stay the course
We appreciate that recent market declines can be painful for investors, particularly those who have entered the markets in the past 12 to 18 months. It is normal to feel emotionally affected by downturns. But we also think the best course is not to panic and to avoid switching into cash. In particular, there is a risk that the real value of cash holdings could fall, given that interest rates on current accounts are currently dwarfed by inflation.
Equally, we believe there are potential hazards in switching to investments with a different risk profile from the one suggested by your financial adviser. Portfolios are designed to go through periods of market decline and you could potentially end up deviating from your long-term plan. If you are considering changing your investments due to current conditions, then we recommend you contact your financial adviser beforehand.
In the end, though, we do face political risks in the UK, continuing risks associated with the tragic events in Ukraine, and the possibility of further market falls. We think the best response to this is to stay diversified, in other words to ensure you do not have all your investment eggs in one basket.
Markets have rebounded quickly in the past and they could potentially do so again. In our view, there are benefits to investing for the long term in a portfolio that is in line with the level of risk that is right for you.
(1) “Jeremy Hunt has shredded the prime minister’s economic policy”, The Economist, October 17, 2022.
(2) FactSet, 31/12/2021 to 13/10/2022.
(3) Prices of Brent crude oil and the FAO Food Price index, Refinitiv and Schroders Economics Group, August 26, 2022.
(4) FactSet, JP Morgan Asset Management, September 2022.
(5) “Bonds climb as investors flee stocks”, CNN Money, August 17, 2009.
Any views expressed are our in-house views as at the time of publishing.
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