Fairview Monthly Update - October 22

September 2022 was certainly a historical month for Britain. It will clearly be best remembered for the death of the Queen and succession of King Charles III. There was also the appointment of a new Prime Minister, Liz Truss who kept her word of her administration being “ready to hit the ground from day one” (sic) with a mini budget that rocked investment markets. It was a month that most investors will not want to remember (unless you’re a hedge fund manager shoring the pound) with fears of interest rate rises resulting in a sharp sell-off across all asset classes.

For much of the month markets were focused on rising US interest rates and the impact of a strong dollar. The US labour market remained resilient and there was an unexpected increase in retail sales. The latest US inflation reading was higher than expected with a yearly rise of 8.3%. In response the Federal Reserve stated it will do whatever it takes to get inflation under control. The Fed hiked rates by a further 0.75% in September and the data convinced investors that further interest rate rises are inevitable.

In Europe, The European Central Bank has also had to act; with the largest rate rise in its history. It raised rates by 0.75% as Euro zone inflation hit a record high of 10% in September. However, it was action to prevent an energy price catastrophe this winter that was a key focus. A 200bn Euro package was announced in Germany. France had already capped prices via state owned (and recently renationalised EDF Energy with the cost yet unknown). With the war in Ukraine showing signs of escalating towards the end of the month as Russia annexed occupied regions in Ukraine through a corrupt referendum, energy supply is going to remain a key concern going into the winter.

And so, to the UK and what a month for many reasons. There were some positives (believe it or not). Figures showed 0.2% growth in July’s GDP, after a sharp fall in June. In addition, the second quarter fall in GDP has been revised to a gain of 0.2%. ?Interest rates were increased by 0.5%, but the key event in terms of investment implications was the mini budget from the new Chancellor (at time of writing) Kwasi Kwarteng. It is hard to argue that the announcement of an energy price cap was not essential. But it was the new direction for fiscal policy with the focus upon unfunded tax cuts that fueled concerns of inflation and interest rate hikes and led to contagion across UK and global financial markets. UK gilt yields spiked as markets priced in UK interest rates rising to 6% by next May, whilst the pound plummeted before the Bank of England had to step in to announce it would buy back bonds. This did help restore confidence, but the quarter ended with significant volatility particularly in UK assets.

Market Watch

It is no surprise that a perfect storm of geopolitical tensions, rising interest rates and inflation alongside slowing global growth has not provided an easy environment for stockmarket investors in September. Despite the seemingly endless bad news from the UK, the FTSE was no by means the worst performer in September. Yes, it fell by over 5% but of the major markets only the Topix delivered a better return (it fell by 4%), whilst the US S&P 500 fell almost 8%. ?

Chinese equities were hit the hardest as the Chinese economy struggles with the zero Covid policy, a slowing housing market and a fall in demand in exports due to the global economic slowdown. Whilst geopolitical tensions over Taiwan reduce the appetite to invest in the region. The Hang Seng had a shocker falling by over 13% and The Hang Seng is flat over 15 years now on a total return basis and down 36% in capital terms.

Bond markets have been the key focus in September due to concerns over rising interest rates. The UK 10-year gilt now yields 4.08% having started the month yielding 2.8%. But the UK isn’t alone in being in a rising rate and yield environment. The US 10-year treasury now pays 3.83% having started September with a yield of 3.19%. Even the mighty German 10-year bund yields over 2%. For the first time in over seventy years global bonds are in bear market territory (having seen a decline of more than 20% from their peak). With aggressive interest rate rises already priced and the offer of yields at levels not seen since the Global financial crisis the risk reward profile for fixed interest markets is looking much more interesting.

The other key theme for markets in September is the dramatic fluctuations in currencies. In particular the strength of the dollar and in the last week the volatility of the pound. During September the pound fell 4.3% against the US dollar and 1.7% versus the Euro (but was broadly flat against the yen). Whilst the recent fall in sterling cannot be ignored the key theme is still a US dollar strength story against virtually all currencies rather than a specific weakness in the pound. The weakness in the pound does have some compensations. For sterling investors, with US exposure the pound falling versus the dollar helped cushion fund losses during the month (although it’s not great if you are on holiday in the US!)

It was a tough month for commodities and both gold and oil had poor months. Gold does well in a falling real rate environment – not sure when we will get one of those next! During September it fell $54 to finish at $1672 an ounce. A barrel of brent now changes hands at $85 after dropping $7 during the month. One of the more interesting interviews last month was with the CEO of Saudi Arabia’s national oil company Aramco who pointed the blame at a decade of underinvestment in oil and gas for current high prices and not just Putin’s invasion of Ukraine; in other words, even when the war ends prices are unlikely to suddenly drop.

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Fund Watch?

In the fund world there were a few clear stories. The weak performance of both gilts and listed property shares and the dominance of dollar debt funds, albeit translated back to sterling. There were five positive IA sectors in September with the USD Government Bond sector winning the race with an eked out gain of 1.25% - aided and abetted by sterling’s fall. Two additional US bond sectors completed the top three followed by Healthcare and Latin America being the only other sectors to post positive returns (albeit a measly 0.04% and 0.01% respectively). At the foot of the table and with wild swings in the last week of the month the UK Index Linked Gilt sector propped the tables with a fall of over 17% followed by the Property Other sector with a fall of 10%. The latter has been hit by concerns over rising interest rates and a broader economic slowdown.

Looking at individual funds, and there were some stand out performers, mainly esoteric trend driven funds or absolute return style ones. Oxeye Hedged Income topped the tables with an 18% return. There were some “normal” funds near the top ten, such as Axa Framlington Biotech which gained 4.5% helped by a weak pound and investors are taking advantage of depressed valuations.

At the bottom of the tables, there was one type of funds dominating: listed property. Eight of the ten worst performers were all listed property funds, both UK and European funds in equal measure. NFU Mutual UK Property Shares took the plaudits for last place with a decline of 20.95%.

The investment trust universe gave different outcomes to the open-ended world, due to the esoteric nature of many trusts. The Property Rest of World sector topped the table with a return of 9.15%. However, there are only two trusts in that sector with one gaining 17% in September and the other falling. Similarly, the second placed sector, Insurance & Reinsurance which gained 3% only also has two constituents. For the record, Macau Property Opportunities was the best performing trust last month gaining 17% closely followed by Catco Reinsurance which was up 13%. Third place went to the soon to be wound up Fundsmith Emerging Equities which delivered a 10% return as the discount narrowed sharply. All isn’t shiny in trust world with a sharp widening of discounts in many areas with infrastructure and many of the newer specialist sectors and trusts particularly hard hit as the long-term discount rate increased on the back of rising yields, which results in falling values.

Manager Watch

Bond managers took centre stage during the month and M&G’s Head of Fixed Interest Jim Leaviss is always worth a listen (Uncle Jim’s World of Bonds podcast). He didn’t see a lot of understanding economically of the Kami- Kwasi mini budget and emphasised that the cost of borrowing for UK Govt is going to be significant (and would not rule out a downgrade of UK debt). His view is that with the Bank of England having its foot on the brake and Govt with foot on accelerator, this is not a healthy situation to be in and likely to lead to further unease in markets.

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