Where do stock markets stand now? – an HL fund manager’s view

Westminster has been ‘running hot’ in recent months, and all too often the events have had dramatic consequences for markets.

The mini-budget Kwasi Kwarteng presented was anything but mini in its impact. Essentially, he committed the government to lots of spending, without any accompanying taxation measures to fund them. Markets reacted in horror, the Conservative party seemed to enter panic mode and the rest, as they say, is history.

Many of the mini-budget’s measures have now been reversed and even the help with utility bills is under review for the period beyond the start of spring. So, will there be lasting consequences from the turmoil of recent months? Let’s look at what actually happened, and where markets stand now.

Sound as a pound?

Much was made of the collapse in the value of the pound that occurred after the mini-budget. Sterling did indeed drop swiftly in the immediate aftermath, but it quickly recovered. The pound is now worth more than it was before the ill-fated chancellor stood up to deliver his mini-budget.

The dollar versus the pound from the mini-budget date

Source: Bank of England, to 08 November 2022.

The currency markets were deeply unimpressed at first. During Asian trading hours on the Monday after the mini-budget, sterling fell to as little as $1.04, before quickly bouncing back.

Now the spending plans been reversed, there’s a more conservative, with a small ‘c’, approach to making expenditure commitments at the Treasury. Confidence in the value of the pound has improved as a result.

The UK’s import bill is no longer rising as a result of a weak pound. However, given that a year or so ago a pound would’ve bought you over $1.40, it’s still substantially higher than it was. This has a direct impact on the cost of energy and foreign-made goods. This puts pressure on household incomes and company profit margins, unless they can increase earnings or selling prices respectively.

Interest rates and bond yields

The cost of a new mortgage is a lot higher now than it was before the mini-budget. The cost of two-year fixed-rate mortgages has more than doubled over the last year, with much of the increase coming in the weeks since the mini-budget.

Rates were already rising, pulled higher by inflation and the Bank of England raising the base interest rate seven times already this year. Lenders are increasingly anticipating future increases and pricing them into their rates, leaving fixed rates far above the current base rate.

This is clearly troubling for borrowers, and businesses alike. The effect isn’t yet widely felt. That’s because people and companies on fixed rates will see no increase until their rate deal comes to an end. There will be a rolling wave of discomfort as borrowings are repriced to the new levels.

The flip side of borrowers’ pain is savers’ delight. For a decade or so, the returns on bank deposits have been very low. Now savers, if they shop around, can find far more attractive rates.

Shop around with Active Savings

There were chaotic scenes in the bond market following the mini-budget. Sharp price movements had caused pension funds to need to post more collateral against hedging contracts. This led to the funds becoming forced sellers of the very bonds they rely on to deliver more certainty of long-term returns.

They were not going bust, for the increase in yields had shrunk their liabilities, but the liquidity squeeze forced the BoE to step in as a buyer of last resort to return order to the market. Yields have now returned to levels close to where they were before Kwasi Kwarteng stood up. But they’re still several percent higher than they were at the turn of the year.

What can investors do?

When the future looks even more uncertain than ever, diversification should be investors’ first thought. The world is stepping away from an era of ultra-low interest rates, a decade or so during which asset prices pushed ever higher. The inflation that has appeared threatens to upend all of that.

Deflation, not inflation was seen as a more likely future and trillions of dollars-worth of bonds had been offering negative prospective yields. Companies had been raising funds at trivial rates of interest. No longer. Yields on US government debt have risen through 4% and company borrowing costs have almost doubled to just under 6% according to Moody’s rating agency.

Times are going to be tougher for many in the next year or two, until inflation is tamed, and interest rates settle down. There’s no guarantee, not perhaps likelihood that they’ll settle at levels below today’s rates, unless inflation is truly kicked into touch.

Companies will need to have secure revenues and good cost management skills to prosper through the coming quarters. The UK has no particular ‘safe-haven’ status. Our reliance on relatively short mortgage fix terms means we could feel the impact of rising rates harder and sooner. International diversification can spread that risk.

Company profits are set for a squeeze. Governments want more taxes, costs are rising and financing company debts is getting more expensive. And that is before trading suffers from the tougher economic conditions. Defensiveness looks attractive right now – dull and dependable has never looked so attractive. Any asset where the value depends on the availability of abundant cheap finance should be treated with great caution.

After years of regarding bonds as overpriced, I’m not sure that case is so strong anymore. The near 6% prospective yield Moody’s is reporting is interesting, if inflation comes ebbing back as rates bite. That’s the highest level I’ve seen from corporate bonds in over a decade to date.

Company bonds are not risk-free though. Companies can default if they hit tough times. They can have exposure to higher-risk high-yield bonds and ultimately there are no guarantees, so you could make a loss. Remember, yields are variable and not a reliable indicator of future income.

We can’t wish away hard times. But if we focus on quality and defensiveness, diversifying portfolios around the world and into different types of assets, then we can help weather-proof portfolios. In the long run, being invested in markets has proven a way to generate longer-term wealth.

This article is not personal advice. If you are unsure of an investment for your circumstances, ask for financial advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

Steve Clayton is a Fund Manager of the HL Select range of funds. The HL Select funds are managed by our sister company Hargreaves Lansdown Fund Managers Ltd.