The same but different

While some of us may have suffered the January blues, markets started off the year on a positive note having finished the month with strong performances across the board.

Key drivers for this upbeat start include Europe’s mild winter – which brought down projections for future energy prices – and China reopening its economy. More optimism from central banks that inflation could continue to slow down in Europe and the US also helped bonds and equities finish January positively – although risks of recessions remain.

Rising inflation seems to be behind us now. And although it’s still quite high, investors believe central banks won’t raise interest rates as much as last year to try to tame it. That’s potentially good because rapidly rising rates tend to be bad for markets.

But despite the positive start, the all-important US could still have a challenging year ahead with 2022’s interest rate rises taking their toll on its economy. It’s becoming difficult for people to borrow, which is causing a dip in retail sales. This, along with a weakening housing market, could cause its economy to slow down later this year.

Markets are in a transition phase right now, as Lilian Chovin, Head of Asset Allocation at Coutts (the bank behind the NatWest Invest funds), explains.

“On one hand, inflation pressures have eased, but it’s too early for central banks to start cutting interest rates,” he says. “On the other, China is opening up while the US economy continues to slow down and could move toward a recession.

“With this uncertain landscape front of mind, we’re managing our portfolios and funds cautiously.”

Across transport, NHS and other industry walkouts, the UK witnessed 25 days of strikes in December, and 20 days in January. This brought the total number of strike days in 2022 to a 30-year high, according to the Office for National Statistics.

While the reasons behind the strikes vary from sector to sector, one common factor is the cost of living crisis, with inflation on goods and services not being matched by increases in people’s wages. With a very low unemployment rate and a shortfall in available staff, workers are in a strong position to negotiate pay raises.

So what’s the impact of all this? Well, for the Royal Mail, its recent staff strikes cost the company £200 million. For the wider economy, it’s not quite so easy to calculate.

While the strikes are impacting the day-to-day lives of most people, their spending is unlikely to dwindle – they’ll just spend their cash in different places. For example, instead of buying their coffees or lunches at stores close to their offices, they’ll likely just buy them closer to home.

Overall, looking at recent examples in other countries, industrial actions have generally had a limited impact on economies. So we don’t expect recent strikes to be a key driver of the UK economy in 2023. 

While many investors will be glad to see the back of 2022, a year of rising prices and interest rates denting market returns, there are reasons to be hopeful when we all sing Auld Lang Syne. We’ve actually seen some positive market performance recently.

The reason for the recovery? Annual inflation fell in the US in October – a sign that, while prices are still going up, they’re not going up as fast.

This gave investors hope that America’s central bank – the US Federal Reserve – might take its foot off the gas when it comes to raising interest rates. It also sparked speculation that those rates could even peak and start falling in the first three months of next year. The Fed raised rates in December by 0.5%, a smaller hike than previous announcements.

This matters because America has a huge influence on stock and bond markets around the world. And if interest rates don’t rise as much or start falling it can be good for companies’ borrowing costs, profits and, therefore, share prices. Bond markets also tend to benefit from stable interest rate environments.

Monique Wong, Head of Multi-Asset Portfolio Management at Coutts, the bank behind NatWest Invest, said: “We’re still cautious looking into next year. Economic growth is slowing and recessions appear increasingly inevitable.

“However, we expect 2023 to be a more constructive year for investments. Interest rates are peaking and bond markets now provide an attractive yield.”

We’ve seen similar price moves in the UK, with inflation in the year to November falling to 10.7%, from 11.1%. We believe UK inflation is near its peak and should slowly drop towards 6% by next summer.

The Bank of England (BoE) raised interest rates by 0.5% this month – which, similar to the Fed, was a lower rise than previously. But what might happen next year?

We believe interest rates will peak at around 4.25% to 4.5% next May. The first BoE decision, in February, could still be a 0.5% rise, but we could see smaller, 0.25% moves in April and May.

There are many factors at play here though. The forthcoming recession in the UK could be deeper than expected, which could cause interest rates to peak sooner (although the experts at Coutts aren’t seeing anything to suggest that yet). On the other hand, strong pay growth suggests risks of inflation becoming more embedded, leading to higher rates for longer. 

Those rate rises just keep on coming. Both the Bank of England and the US Federal Reserve (Fed) raised interest rates again recently. And both by a chunky 0.75%.

They’re doing it to try to rein in rising inflation. So it’s interesting that we saw a bit of a turnaround in the market’s mood on rising prices in the US last month.

When the latest US annual inflation number came out in October, it was higher than expected (8.2%). But although the country’s stock markets initially swooned, they soon recovered and actually ended the month pretty strongly.

Lilian Chovin, Head of Asset Allocation at Coutts – the bank behind the NatWest Invest funds – explains why.

“The market believes the Fed is going to ease the pace at which it raises interest rates,” he says. “It can’t keep hiking them by 0.75% forever. Whichever way you look at it, economic growth is slowing in the US, which should naturally start bringing down how much people spend as we move into next year.

“This in turn should start easing inflation and mean less need for big rate hikes, at least in America. But that’s important because of the huge influence the country has on global markets.”

Rishi Sunak’s appointment as Prime Minister should help restore some credibility back to the UK and see its government and central bank pull in the same direction – both good for investors.

Sunak has big challenges ahead of him though. He needs to cut public spending by around £30-£40 billion a year to help close the country’s budget deficit, which is around £70 billion according to the Office for Budget Responsibility. And however he does it will probably be unpopular amid a cost of living crisis.

More broadly, the UK outlook for 2023 remains difficult given spending cuts, a likely recession and elevated inflation. Coutts saw challenges ahead for the UK economy earlier this year and reduced their exposure to parts of the UK stock market most at risk, and UK government bonds. 

The team at Coutts made two changes within the NatWest Invest funds over the past month to reflect current conditions. They:

•  invested more in US government bonds given higher yields.
• reduced their allocation to Japanese government bonds because of interest rate  uncertainty in the country which could hurt their performance. 

It was a ‘mini-budget’ with a massive impact. The government’s announcement on Friday turned out to be the biggest set of tax cuts in Britain for years. It led to UK markets falling and the pound reaching a record low.

We know this kind of uncertainty can be unsettling when investing. It’s worth remembering that, with NatWest Invest, you have a team of experts in your corner from Coutts bank. And they had already diversified the funds’ exposure away from the UK earlier this year.

As always, we believe it’s best to stay focused on your future goals. How do markets look over the longer term (usually around five years or more)? And how does that match with what you want from your money over time?

New Chancellor Kwasi Kwarteng’s tax cuts came thick and fast as he took to the floor in the House of Commons on Friday. They included:

• lowering income tax
• reversing a recent rise in National Insurance payments
• slashing stamp duty to help those buying a house
• throwing out plans to raise taxes for businesses

On the surface, it all sounds pretty good, doesn’t it? The moves are all designed to put more money into our pockets and stimulate economic growth.

But the big question is: how’s the government going to pay for it all?

And with inflation already at record highs, encouraging us all to spend more could see it spiral out of control.

This in turn could force the Bank of England to raise interest rates faster and higher – there’s already talk of it holding an emergency meeting to discuss raising rates sooner than usual. This could mean monthly mortgage payments shooting up and loans costing more to pay back.

All this has led to the lack of certainty and confidence in the UK economy.

The Coutts’ team behind NatWest Invest had already made changes to cushion the blows from current uncertainty. This involved:

• diversifying our bond exposure away from only UK government bonds to a basket of bonds from the G7 countries – the US, France, Germany, Italy, Japan, Canada and the UK.
• reducing how much we invest in parts of the UK stock market most at risk.

It’s also worth remembering that the team invests all around the world to make the most of multiple markets without being exposed to too much risk from one place.

Our experts will continue to keep a close eye on what’s happening, look out for risks and opportunities and make changes as and when necessary. Their single goal is to help ensure your money is well positioned for whatever’s happening in the wider world.

Our new Prime Minister Liz Truss had barely finished moving into Downing Street when she introduced her first policy to help people through the cost-of-living crisis.

She took to the House of Commons and announced a cap on average household energy bills of £2,500 a year for two years.

With inflation rising to record levels and wages failing to keep up, the UK is facing a cost-of-living crisis, weak currency and slower economic growth. Truss’s new energy bill policy could help turn that around a little, at least in the short term.

But it may mean challenges in the long term.

The energy bill cap could cause inflation to settle at a lower peak than initially expected, and then start falling (having risen rapidly for most of the past year). This in turn could lead to less aggressive interest rate rises from the Bank of England.  

We’ve already seen inflation ease a little, largely because of falling petrol prices. It dropped to 9.9% for the year to August, down from 10.1% in July. Current expectations are for it to remain high, but Truss’s cap should flatten out where it peaks by the end of this year.

Energy prices have been a huge factor in inflation’s meteoric rise, so cutting what people pay for electricity and gas will bring down the overall inflation level. Forecasters who had said inflation could reach the high teens are revising their numbers down to the low teens.

But – and you knew there’d be a but – this kind of economic support from the government could ultimately fuel further inflation (pun intended). This is particularly likely if it comes alongside the possible tax cuts Truss has talked about.

Not all the new Prime Minister’s plans have been announced yet, but indications are that tax cuts will be quite broad. This would put cash back into people’s pockets – cash they very well may spend. And this could keep inflation and interest rates high. 

Monique Wong from Coutts, the bank behind the NatWest Invest funds, says, “The energy bill cap makes it less likely the Bank of England will raise interest rates aggressively – interest rates will still go up in the coming months, but less than markets expected. In the near term, that could be good for bond investors. However, we still want to see the details of the Prime Minister’s plans.”

She adds, “Counter-intuitively, this may not have a large impact on all UK stocks. The FTSE 100, for example, is made up of multi-national companies whose revenues are derived from overseas – so it’s more exposed to the global macroeconomic environment than domestic UK policies.”

We saw dark clouds on the investment horizon in the UK earlier this year, and had already positioned the NatWest Invest funds appropriately. As a result, they are now less sensitive to UK events.

We reduced our exposure to UK stocks, and diversified our bond exposure away from only UK government bonds to a basket of bonds from the G7 countries – the US, France, Germany, Italy, Japan, Canada and the UK. 

Our latest investment update finds markets bouncing back from previous falls, largely led by the US.

The temperature hasn’t been the only thing soaring. Inflation in the US surprised everyone recently – again – by rising rapidly. Prices shot up 9.1% in the year to June, up from 8.6% in May, according to the Bureau of Labor Statistics.

But investors are now well used to these rising numbers and already focused on what comes next. As a result, markets actually had a pretty good month – the MSCI All Countries World Index returned 7.1% in July in local currency terms, compared to -7.4% the previous month. A large part of this was driven by good performance in the US, with the MSCI USA returning an impressive 9.3%.

Monique Wong from Coutts, which manages the NatWest Invest funds, explains.

“The forward-looking nature of markets means stock and bond performance usually reflects what investors think could happen in future, rather than what’s happening today,” she says.

“And with economic growth slowing and, by implication, recession risk rising, investors are speculating that central banks will pause or hold back on aggressive interest rate increases.”

America’s central bank the US Federal Reserve has already suggested it could start raising interest rates at a slower pace, a message welcomed by markets.

According to initial estimates from the Bureau of Economic Analysis, the US economy looks to have shrunk at an annual rate of 0.9% in the second quarter of this year. This follows a drop of 1.6% in the first three months of the year.

That’s two quarters of a shrinking economy, and that’s the technical definition of a US recession.

But is it a recession? Really?

Monique says: “To use the ‘r’ word about America feels a little strange because there’s still so much to shout about regarding its economy.

“Growth has slowed, sure. Business and consumer sentiment have been hurt by higher prices. However, the labour market continues to be strong. It would be a curious recession where everyone has a job and companies are still investing in their own businesses.”

We recently increased our investment in US stocks. We believe the country looks more resilient to an economic downturn than, say, Europe, which was hit hard by the energy crisis caused by Russia’s invasion of Ukraine. Meanwhile, rising inflation and political uncertainty is taking its toll here in the UK.

We’ve also diversified our bond holdings away from just UK gilts to a basket of bonds from the G7 countries – the US, France, Germany, Italy, Japan, the UK and Canada.

We’ll actively increase or decrease how many bonds we hold from each region in line with how we think they’re doing. 

World events and the influence of politics on stocks and bonds in recent years underline the importance of having truly global funds. Stick with one country and you could soon get unstuck in our opinion. We’re big fans of not putting all our proverbial eggs in one proverbial basket.

Take the UK and the US for example. Two very different places currently in two very different places from an investment perspective. 

In Britain, with a new Prime Minister set to be announced in September, the future direction of the country’s economic policy is unclear. On one hand, a likely recession puts pressure on the candidates to promise they’ll stimulate the economy, through tax cuts for example. But at a time of eye-watering inflation, the Bank of England might yet maintain high interest rates, which could curb economic growth. Indeed, rates have just gone up again in the UK from 1.25 per cent to 1.75 per cent – the biggest increase in 27 years.

Meanwhile, with currency a key measure of how investors see a country, sterling was pretty weak throughout the first half of the year.

But in comparison, the US is relatively settled politically and insulated from the economic problems caused by Russia’s invasion of Ukraine. The jobs market there is particularly strong – on average, about 450,000 jobs were created in America each month over the first six months of 2022, according to the US Bureau of Labor Statistics.

This has all filtered through to positive market performance state side. As a result, our own stock holdings there supported our performance in July while helping offset the challenges we’re seeing elsewhere.

It’s been an eventful year so far for investors with a handful of factors affecting market performance. Here are three key points we think worth knowing.

The price of goods and services continues to rise, with US inflation rising by 8.6% in May compared to last year, higher than expected. Central banks now have the challenge of trying to bring prices under control without stifling the growth of their economies too much – usually done by raising interest rates.

And for now, those rate rises keep on coming as their efforts to tackle inflation continue. Last week, the Bank of England raised rates from 1 per cent to 1.25 per cent, and the US Federal Reserve announced a rise of 0.75 per cent – its biggest hike since the mid-90s.

Climbing prices are likely to peak in the US later this year, but this might not be the case for the UK. Utility prices are expected to rise in October which, along with a relatively low number of workers available, could mean inflation stays higher for longer in Britain. 

China’s strict zero-Covid policy caused its economic growth to go into slow-motion over the last couple of months. But that could be changing. People and businesses there are starting to borrow more, which is usually a sign of better economic activity to come.  

Being the second-largest economy in the world, China is very important for global growth. So investors are keeping a close eye on the country.

The Coutts team behind our customers’ investments anticipated today’s challenging conditions and had already made changes to help navigate them.

These include:

• recently investing more in US companies as they are currently well-priced and we expect inflation to settle in America later this year, which should in turn settle markets
• cutting back on bonds before they were negatively hit by rising interest rates
• reducing European equities at the end of 2021 in anticipation of a tougher economic outlook for Europe