The FTSE 100 market fell slightly last week, in a period dominated by political changes.
UK Prime Minister Boris Johnson had been facing questions over his handling of former deputy chief whip Chris Pincher, who has faced a string of sexual misconduct accusations. The week started with UK Chancellor Rishi Sunak resigning from his position as chancellor, alongside Health Secretary Sajid Javid.
Although the FTSE 100 had struggled at the start of the week, it actually remained relatively flat following Johnson’s announcement. The more domestically focussed FTSE 250 rose 0.3% following the news.
Giving his view on what Johnson’s resignation means, Ben Lambert, Portfolio Manager at Ninety One, explains: “Our base case view is that Johnson’s resignation will have greater party political rather than economic policy implications in the near term. This is because his successor’s legitimacy remains nominally tied to the policy platform that received an electoral mandate in 2019.
“This view is of course contingent on his eventual successor not calling a snap election, which we don’t anticipate in our base case but acknowledge is a non-zero probability event. The limited immediate reaction in equity markets would seem to confirm this view.”
Sunak is the early bookmakers favourite to succeed Mr Johnson. He is likely to continue his economic policies. A number of rival candidates have suggested they would consider additional fiscal spending or tax cuts, or a return to austerity.
“The outlook hinges on who Johnson’s replacement will be. A return to traditional Conservative politics will probably bring about some austerity over the next few years, but also a return to business-friendly policies. However, another populist politician could lead to more of the same approach for the economy,” noted Azad Zangana, Senior European Economist and Strategist at Schroders.
With inflation still rising, the UK facing a cost-of-living crisis, and with several Brexit related questions still posing challenges (for example the Northern Ireland Protocol) whoever does eventually succeed Johnson will have a series of immediate issues to face, and their policys could influence the outlook for UK companies over the second half of the year.
After a brutal first half of the year for US markets, both the S&P 500 and NASDAQ Composite started the second half of 2022 more positively, rising 1.94% and 4.56% last week respectively. Adrian Frost from Artemis pointed out that since 1957, in the years the S&P 500 had a negative first half, it’s also fallen in the second half about 50% of the time.
He added: “Although it’s been better this week, sentiment on the whole remains understandably fragile: machines seem to be chasing different parts of the market up or down, depending on the latest macro data such as the latest on US employment.”
This employment data showed payrolls rose by 372,000 in the US in June, far in excess of the consensus expectation of 265,000. With the jobs market still appearing relatively healthy, this suggests the Federal Reserve is likely to continue to increase interest rates when it next discusses the issue at the end of July , where most are expecting another rate rise of 0.75% or 0.50%.
Felipe Villarroel, Partner at TwentyFour Asset Management, suggested that, while the market may not yet be bottoming out, some of the drivers of the high inflation may be coming down.
Oil and gas have been primary drivers of inflation so far this year. However, he noted that, over the past month: “Most commodities have seen price declines that are quite substantial, with oil falling close to 10% in a day this week and down 17% in the last month. One-month performance in other products has followed suit, with aluminium down 12.25%, copper and nickel down around 20% and notably wheat down 27.5%.”
That said it is important to remember the situation remains volatile. For example, this week Russia is temporarily shutting down its gas pipelines Nord Stream 1 for repairs, which is likely to further inflate prices, and could have an impact on European markets.
If these are falling due to slowing demand, then the Fed’s efforts may be starting to pay off. And only once they have achieved their aim of reducing inflation will they begin to relax their monetary policy.
It is important to keep things in perspective, however, and there remain a number of future headwinds which will likely keep the investment environment difficult. The war in Ukraine is showing no signs of ending, and there remains a real risk of a recession, for example. For investors, it seems unlikely that we are out of the woods yet.
This year has seen inflation rise to levels not seen in decades. This is causing something of a ‘cost of living crisis’ for many, as basic household goods become increasingly expensive.
Governments and central banks haven’t sat back idly by, but have taken action to try and limit inflation. One of the levers central banks have is to increase interest rates. Higher interest makes it more expensive to borrow, which generally reduces spending and therefore inflation. Of course, this creates its own challenges. For a population already struggling with the cost of living, additional costs are unwelcome. With many economies still fragile, there is also a risk that if banks were to increase interest rates too much, it could cause a recession.
For investors, this has created a difficult situation. Although we know we are facing high levels of inflation and increasing interest rates, there are still questions we cannot know the answer to. For example, is this inflation transient? How much of the inflation is being caused by the war in Ukraine, and how much of it is the aftermath of COVID-19? Different asset classes will react differently depending on the answers to these questions. For example, you may have seen the word ‘stagflation’ mentioned in recent weeks.
This is where we have high inflation coupled with a recession. In this scenario, there are very few places to hide, but typically commodities perform best. Unfortunately, this asset class often struggles in other scenarios – for example, if this inflation turns out to be transient and central banks become too aggressive. This could drive inflation down too far, just as the economy falls into a recession. In this case, you would want to be invested more heavily in bonds. And what if central banks get it ‘just right’, where interest rates help bring down inflation, and we return to growth. In this environment, it is better to invest in equities.
The key here is to ensure you hold a well-diversified portfolio, containing well thought-out asset allocations for your risk profile. This way, you will not be too exposed to any one asset class, reducing the risk of volatility, and will be well placed to benefit from any future bounce-back, whatever form it may take.;
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society, as the value & income may fall as well as rise.
I am lost words for what this trophy means. It has always been and always will be the most special tournament. Realising a childhood dream in winning this trophy. Every year it gets more meaningful, I am really blessed. The most special court in the world.
Novak Djokovic on what Wimbledon still means to him, after winning the latest tournament.
Artemis, Ninety One, Schroders and TwentyFour AM are fund managers for St. James’s Place.
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