The word of the year ‘permacrisis’ perfectly embodies the period of continued upheaval

As we move into November, many investors will be forgiven for wanting to see the back of 2022 with economic uncertainty at home and abroad through October compounding the gloom. Collins Dictionary declared ’permacrisis’ the word of the year – an extended period of instability and insecurity – and events of the past few weeks have certainly been in keeping with this theme. The UK has been a poster child for this new term, starting October with Liz Truss and Kwasi Kwarteng still promoting the benefits to growth which could be achieved by the ill-fated mini-Budget, and ending with a new Prime Minister and Chancellor, and so called Trussonomics dead in the water.

What is happening in the UK

The Truss government’s low tax, high borrowing plan was at odds with many things, not least a hawkish Bank of England determined to tame inflation, sparking a market exodus from UK government debt as investors questioned the UK’s standing as a reputable borrower. Piece by piece, the government’s plans were dismantled by new Chancellor, Jeremy Hunt, reneging on commitments such as Corporation Tax freezes and a 1p reduction in basic Income Tax to restore credibility. We now find ourselves back in a position of monetary and fiscal orthodoxy with the Bank of England and Rishi Sunak’s government both singing from the same hymn sheet and inflation containment at the top of the agenda.

So, are we back where we were before the mini-Budget? Not quite. Tough choices lie ahead for the Chancellor when he does finally deliver his fiscal statement on 17 November and the focus has shifted from boosting growth to bridging the gap between government borrowing and tax receipts against a challenging global picture. Hunt has warned that taxes may need to rise, and public services may be squeezed at a time when the Bank of England is warning of the longest recession on record, which has most likely already started and is forecast to stretch well into 2024.

With inflation remaining stubbornly high, interest rates were ratcheted up 75 basis points to 3.0% at the Bank’s latest Monetary Policy Committee meeting and they will be looking for the economy and the jobs market to cool and prices to begin to plateau before taking their foot off the gas.

Despite the political and economic backdrop, the FTSE 100 pushed higher through October, with BP and Shell both reporting bumper Q3 profits as the fallout from the conflict in Ukraine continued to support oil and gas prices. By contrast consumer discretionary businesses face a tougher winter with online furniture retailer Made.com perhaps a harbinger of things to come, plunging into administration little more than a year after floating on the stock market, valued at £775 million.

The squeeze on consumer finances and rising input and borrowing costs may push others into distress but it should be said that many companies enter this winter with relatively healthy balance sheets when compared to previous recessions, have scope for cost cutting and in time are likely to be able to pass on increased costs.

What is happening in the US

For global markets, the focus remains the US Federal Reserve’s interest rate path. At the Federal Open Market Committee meeting in October the Fed also hiked rates by 75 basis points (for the fourth time in a row), bringing the upper bound of the target rate to 4%. Quashing any dovish notions, Fed Chair, Jay Powell, pushed back against the idea of premature rate cuts (markets were pricing in a Fed ‘pivot’ of two 25 basis points rates cut by December 2023) and emphasised again that the risk is doing too little rather than too much.

We know the Fed expects peak interest rates to get higher than previously thought (albeit reaching that via a slower pace of tightening), but there is a lack of clarity over how high that will go (the tipping point between rates choking off demand). Since the labour market remains strong, more tightening would be needed to cool the overheating, and a recession is more likely than not in the journey to bring inflation down.

On the whole, US earnings remain in good shape but forward guidance was less positive through the recent Q3 reporting season. Energy and industrials gained on robust earnings whilst tech bore the brunt once again as both macro dynamics and earnings outlooks shifted against them. Amazon, the darling of the past decade, has halved year-to-date and Facebook owner Meta is down over 70%, the latter announcing 13% of staff will go as slumping advertising revenues and big bets on long term project, the Metaverse, left investors unenthused.

What is happening in China

Across the Pacific, speculation that China will relax its Zero COVID strategy led to the biggest weekly jump in the Hang Seng Index since 2011. Is that sustainable? Well, reopening would certainly be great news, but so far the rumours appear unfounded and Chinese health officials have since reaffirmed their commitment to Zero COVID.

In the event China does relax restrictions, the reopening process will take time. On that front, it is worth bearing in mind that the relative performance of Chinese company profits vs the rest of the world has been disconnected from its economic outperformance for a long time. Aside from COVID, investors are likely to remain concerned on the political and geopolitical implications after the cabinet reshuffle by President Xi at the National Party Congress. The tensions between the US and China, and China and Taiwan, will not go away.

As we approach 2023

So, with 2023 in our sights, the outlook for the global economy appears to be worsening and the path of least resistance might point to recession. That said, stock markets remain forward looking and with much of the pain already priced in too many assets, we may be approaching something close to the bottom. Investors will be looking for a catalyst, be that falling inflation and interest rates, the labour market cooling, or a resolution in Ukraine – however remote that possibility seems today.

Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at Brewin Dolphin)