Choppier Waters

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Global equities have slipped back in the last couple of weeks and ended last week down 2.0% from their high on 6 September. UK and European equities have also opened 1.5-2% lower this morning.

This setback is not a big surprise given a correction is well overdue, as we’ve highlighted before. We have not seen a fall of 5% or more since last October whereas the norm is to see such declines twice a year.

The retreat is all the less surprising as the economic data has become distinctly more mixed in recent weeks, pointing overall to rather lower growth and higher inflation than expected. This past week has seen a raft of numbers released in the US, UK and China.

Starting with the US, the latest news in fact provided a pleasant surprise. Retail sales were stronger than expected in August, recovering some of their fall in July and easing some of the worries created by the weak employment report of a couple of weeks ago. Meanwhile, inflation came in a bit below expectations, with the core measure easing further to 4.0% from a high in June of 4.5%.

By contrast, the recent UK numbers have provided an unpleasant surprise. Retail sales unexpectedly fell again in August following a sizeable drop in July. Still, they remain 4.5% above pre-pandemic levels and some of this weakness will just be down to shortages and a switching of spending away from goods to other areas.

The labour market also remains red-hot. Job vacancies have hit an all-time high of over 1 million and wage growth is running at around 8%. However, with the furlough scheme now drawing to an end, the labour market should over coming months return towards some sense of normality.

As for inflation, this saw an unexpectedly large jump last month to 3.2% from 2.0%. While base effects, associated with last August’s ‘Eat Out to Help Out’ scheme were partly to blame, the bad news is set to continue for a few months yet. Indeed, the surge in wholesale gas prices, which is now causing problems for companies ranging from gas providers to pig farmers, is making matters worse. Inflation looks set to exceed 4% later this year before falling back next year.

The difficulty for markets in interpreting the latest news in the US and UK is not just because much of the data is being distorted by a whole host of competing cross currents. It is also because strong growth, through its boost to corporate earnings, is no longer unambiguously good news for equities as it also hastens the start of monetary tightening.

The Fed and BOE meetings on Wednesday and Thursday will be monitored closely. While no policy changes are expected, investors will be looking for clues as to any changes in the timing of QE tapering and the first-rate hikes.

China is another major focus at the moment and source of worry. The extent of the regulatory crackdown by the authorities on various areas, particularly the tech sector, has caught investors by surprise and growth has also recently slowed more than expected.

There is in addition now a new concern with Evergrande, China’s second largest property developer, on the verge of bankruptcy. However, its demise has been a long time coming and is being ‘managed’ by the authorities who will almost certainly do their best to minimise any disruption caused to the wider economy.

Our portfolios have an allocation to Chinese equities and we plan to retain it despite the current headwinds. The Chinese market is massive, heavily under-represented in the global equity indices and remains a fertile ground for stock-pickers. It is also relatively cheap while China’s longer term growth prospects remain superior to much of the rest of the world.

Similarly, we are not planning to cut back our overall equity allocation just because we have now entered rather choppier waters. Prospective returns for equities may now be considerably lower than of late but they still look significantly higher than for bonds.

Rupert Thompson

Chief Investment Officer