Market Update – August 2022
As the summer draws to a close, the realities of inflation and soaring energy prices are starting to sink in. This month has seen further price increases, a base rate rise, and a worrying energy price cap announcement. Equity markets have shown some signs of recovery this month, mainly driven by better-than-expected US earnings announcements. We are one step closer to appointing a new Prime Minister, but the implications of this for the economy are still unclear.
The Energy Price Cap
One of the biggest news items this week has been the increase to the energy price cap. The cap will rise by 80% in October, to £3,549 per year. This is designed to reflect the energy usage of a typical household, and is by no means a maximum.
From October, the price cap will be reviewed quarterly. Analysts have estimated that it could almost double by next April. Ofgem have cautioned against relying on these estimates as the situation is developing daily.
This will have a devastating impact on many households, with heating being regarded as an expensive luxury this winter. On a wider scale, business energy costs will increase, which will push up prices across the board.
It’s likely that the government will have to step in and provide some support during the cost of living crisis. However, as we are effectively between Prime Ministers at the time of writing, this could take some time.
What Difference Will a New Prime Minister Make?
Liz Truss is the current favourite to win the Prime Ministerial race, but her economic promises are limited and do not seem tailored to the current climate. Initially, the proposals centred around tax cuts and deregulation, moving on to cost-of-living support only after vocal criticism.
Her opponent Rishi Sunak criticised the measures, mainly because providing both tax cuts and a support package would increase public borrowing significantly. Reducing government debt was one of his key promises as Chancellor.
Sunak’s own plan centred around lowering taxes. He does have a track record of providing public support during a crisis, however the measures put in place during Covid appear to have contributed to the current inflationary crisis.
If the public are looking to the new Prime Minister to solve the cost of living crisis, it is likely they will be disappointed.
The Bigger Economic Picture
The annual inflation rate soared to 10.1% in July. The cost of living crisis is worsening, and the energy price increases from October are likely to exacerbate this further. Industrial action has continued throughout August as workers across multiple sectors campaign for better pay and conditions.
Interest rates have risen for the sixth time in the last year to 1.75%. Further increases are likely before the end of the year, particularly as inflation is still spiralling.
Tightening monetary policy can help to reduce inflation, as higher interest rates mean less money circulating in the economy. But the danger is that is can also stifle business growth by making it more difficult to borrow and increasing the cost of existing debts. Mortgage, loan, and credit card costs are also likely to increase.
The Bank of England is fully expecting the UK to fall into recession, and for the economy to continue shrinking until the end of 2023. Recession is a normal part of the economic cycle, but between energy prices, high inflation, and geopolitical instability, the coming months could be extremely difficult.
Are Bonds Still a Good Diversifier?
A good investment portfolio is well-diversified and holds a mix of bonds and equities. In a normal economic environment, bonds provide stability and can help to offset some of the volatility experienced by equities. They also provide an income yield which is a desirable feature for many investors. They can fall in value, but this usually happens when equities are doing well.
In recent months, bonds and equities have both taken a hit. Bonds are highly sensitive to inflation and interest rates, particularly when further increases to the base rate are forecast.
In the last 6 months, the majority of bond funds and bond-heavy portfolios have fallen in value. Most of the main bond indices have dipped by around 10%, and have not yet seen the rally experienced in most equity sectors. The UK Index Linked Gilts sector has lost around 25%, in the last 12 months, which is a level of volatility usually only seen in equity portfolios. It would be reasonable to assume that index-linked investments would do well in an inflationary environment. But bond prices tend to drop when interest rates are rising and index-linked gilts are particularly sensitive to this.
It is still a good idea to hold a wide range of investments and if bonds form part of your strategy, you shouldn’t sell your holdings following a market dip. All of the main asset classes have their pros and cons, and will perform differently throughout the economic cycle. However, the latest developments demonstrate that all investments have their risks and any asset class can lose money, especially in the shorter term.
The UK Market
The UK market is holding steady this month, with the FTSE 100 returning 2.5%. The top performer in August is cyber-security company Avast, which has recently been approved for a merger with NortonLifeLock.
Gambling company Flutter Entertainment has also produced strong returns, and claims to see no signs of a consumer spending slowdown. Of course, this may not be a positive indicator if it means that consumers are diverting their leisure spending to online betting.
Energy companies are still thriving, although it is unclear how long this will last.
The worst performers this month include Hikma Pharmaceuticals, GlaxoSmithKline, and house builders Persimmon and Barratt.
The Global Outlook
The US and global sectors have bounced back strongly this month, following significant volatility early in the year. The US earnings season ran throughout July and August, with many companies announcing higher profits than expected. This restored some confidence to the market, and equity prices have followed suit.
The European sector has stabilised somewhat, and produced a marginally positive return this month. Europe is facing the same inflationary pressures as the UK, as well as bearing the brunt of the Russian energy restrictions.
The Asia Pacific market (led by China) is continuing the upwards trend of the last few months. However, geopolitical conflict, drought, and very modest (some would say overly so) measures to encourage economic growth could all have an impact.
Please don’t hesitate to contact a member of the team for more information on any of the topics covered.
The value of investments can fall as well as rise and is not guaranteed. Past performance is not a guide to future performance.
The content in this article was correct on 31/08/2022.
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