October was an unusual month for markets. The reversal of the mini-budget and subsequent change of government reassured investors that the UK would remain creditworthy, helping UK bonds bounce back after an awful September. This created an odd phenomenon whereby low-risk portfolios outperformed high-risk portfolios. In China, Xi Jinping cemented his hold on power at the Communist Party Congress, as expected. However, markets were spooked when Xi doubled-down on his zero-Covid policy and packed his politburo with yes-men. In a mildly positive month for markets globally, Chinese stocks dropped sharply.
The political circus in the UK may have felt like a soap opera, but importantly it did restore investor confidence in the UK’s fiscal position. The unfunded tax cuts in September’s infamous minibudget had caused a spike in the UK’s relative bond yields, but the gap mostly closed after the cuts were unwound. The change in chancellor and subsequently prime minister further calmed markets, and the pound climbed back to late-summer levels. This was good news for our UK corporate and government bond funds, which rose 5% and 4% respectively.
The latest CPI print showed UK inflation rising to 10.1%, but – with bond markets more concerned with deficits and debt – expectations of interest rate hikes have cooled, with rates now expected to peak at 4.75% next year. Other UK economic data was poor, with official figures showing the economy contracted in August and surveys suggesting further contraction in September and October.
The American stock market had a positive month, as quarterly earnings reports came in stronger than expected. However, broader economic data is getting weaker, with slower home sales, reduced construction, and negative manufacturing and service surveys. Our new hedged US fund proved its worth, more than doubling the equivalent unhedged return from 3% to 7%.
The bright spot remains the labour market, with an ultra-low unemployment rate of 3.5% and rising earnings. However, the headline number disguises the number of workers that have dropped out the labour market, with employment rates still below 2019 levels. The Fed remains under pressure to raise rates, with a 0.75% hike in early November and expectations of another 0.5% in December.
European gas prices eased further in October, and now stand 60% below their summer peak, as a combination of warm weather and growing alternative supply lines have filled continental storage tanks to the brim. Inflation rose to 10.7% and the ECB delivered a 0.75% rate hike. Lower continental energy prices are especially good news for smaller companies, helping our Montanaro European fund deliver over 6%.
In Beijing, the Communist Party Congress confirmed Xi Jinping for a historic third term as president. Xi’s confirmation was universally expected, but markets were caught off-guard when he packed his politburo with loyalists and doubled down on his zero-Covid policy. The politburo has historically brought a diversity of opinion to decision-making, but it is unlikely any of the new members will challenge Xi’s economic whims. Investors believe this will have negative effects on private companies, and Chinese stocks dropped sharply. The weaker renminbi compounded the misery for overseas investors, with the Hang Seng index dropping 17% in sterling terms.
Away from China, the rest of the emerging world was more positive. The OPEC cartel agreed production cuts, which sent oil prices upwards, boosting member countries’ stock markets. Russia agreed to rejoin a UN-backed initiative to allow Ukrainian grain exports via the Black Sea, which should help food inflation in poorer countries. India outperformed, despite lacklustre economic data – industrial production fell while inflation rose – and higher oil import prices.
Japan’s core inflation rate rose to 1.8%, just below its target, but the Bank of Japan was downbeat on how sustainable inflation is. Japan’s fiscal-monetary landscape is a weird inversion of the West’s; the central bank is trying to stoke inflation while the government tries to clamp down. Separately, Japan’s macro data was surprisingly strong, with healthy domestic demand as strict travel rules were relaxed. Corporate earnings were also strong, boosted by the weak Yen.
The global economic outlook is deteriorating. It seems likely the world economy, or at least large parts of it, will enter recession in the next few months. However, asset markets are forward looking, and plenty of bad news is already priced into stocks and bonds. The correlated fall between the two assets has made 2022 uniquely painful for diversified investors, but implied future returns have improved. While stocks can always drop in the short-term, they now offer good long-term returns, and bonds present a compelling diversification prospect once more.