Your monthly market outlook from atomos
The economy can be as unpredictable as the weather, so it's with some trepidation that we take a closer look at what the future might hold for the UK in as we move into autumn. Some key indicators are suggesting further economic weakness is set to unfold. However, we still see some reasons to be cheerful. As always, diversification and active management are the ways we will try to protect your portfolio from any potential economic and market shocks.
Inflation in the UK is still much higher than the Bank of England (BoE)’s 2% target, although it has now begun to drop back. The BoE has been slow to tackle inflation compared to the US Federal Reserve, largely due to its concern about tightening policy when economic conditions were already poor. This early hesitance has led to a need to raise interest rates more sharply, increasing economic pain. There are now several economic signals emerging that we’re watching closely:
Slowdown in manufacturing and services
UK private sector output likely declined in August, hitting a 31-month low on a fast fall in new orders as customers became increasingly cautious about spending. This was according to the Purchasing Managers Index, a survey of senior managers in UK businesses which acts as a barometer of the health of the manufacturing and services sectors.
Lower-than-expected GDP estimate
The preliminary estimate for year-on-year GDP growth for the second quarter showed an expansion of 0.4% which, while positive, was far below expectations.
Small businesses under stress
Data from Sage showed the impact of high inflation on small businesses as sales fell 20% in the past year. SMEs face rising costs and depleting cash levels, while the BoE recently warned of rising corporate defaults as companies struggle with debt. It says half of non-financial firms may under stress by the end of the year, the highest number since the 2008-9 financial crisis. This could have a knock-on effect on employment and investment.
Falling house prices
UK house price indices show London house prices declined 0.6% over the year to the end of June, although overall house price growth remained positive. However, more recent data from Rightmove point to a 1.9% monthly drop in UK house prices, the largest monthly fall since 2018, as higher interest rates push up mortgage costs. It’s unclear as yet whether there will be a silver lining in the form of improved affordability for homebuyers and more first-time buyers getting onto the property ladder.
Housebuilders are very exposed to the UK economy and can give us some indication of its status. In August, shares of the UK’s listed housebuilders dropped sharply after one of the sector’s biggest companies, Crest Nicholson, issued a profits warning. The company said economic uncertainty is deterring prospective home movers.
Rising interest rates
The Bank of England raised the base rate to 5.25% in August. Usually it takes six to 18 months for the impact of policy tightening to feed through in to the real economy so we could see slower economic growth in the UK over the next year as this change takes effect.
We’ve talked about inflation in detail in our last two market outlooks so we’ll just give a brief view here. Bloomberg data shows wage growth in the UK is rising faster than prices for the first time in almost two years, which risks entrenching inflation even further. However, unemployment is rising (from 4% to 4.2% in the last release) so strong wage growth may not last. On balance, we expect inflation to fall given economic weakness and tight central bank policy.
In Europe, we note that the economy is also showing signs of weakness, according to data from the manufacturing and services sectors. Consumer confidence was weak last month, while unemployment expectations increased.
In the US
Nvidia results show the AI revolution is gathering pace
US chipmaker Nvidia reported a blockbuster set of results, revealing revenues more than doubled in the last quarter, beating analysts’ expectations. This strong performance was driven by soaring demand for the chips needed to power artificial intelligence (AI) models. While Nvidia has taken an early lead in AI hardware, the sustainability of its growth will hinge on whether it can also develop the software to accompany this technology. For this reason, and because Nvidia shares look expensive and it is exposed to risks from an AI boom and bust cycle, we don’t hold it directly (as an individual stock) in portfolios.
While optimism about AI may continue, we think valuations are elevated and there is a high level of concentration, where a handful of stocks are responsible for a large proportion of US and global equity market returns. This means portfolios that are too focused on this area could be vulnerable to a fall on any disappointing future earnings news.
Credit rating downgrade
In the US it will be interesting to see what key indicators tell us about the health of the economy, especially given the latest furore around the debt ceiling. In August, one of the big three credit rating agencies, Fitch, downgraded the US’s credit rating from AAA to AA+ following May’s government debt standoff. It pointed to lower confidence in US fiscal management and weaker governance than AAA peers including Germany, Denmark and Singapore.
China deflation vs Japan inflation
Elsewhere in the world, we see an interesting contrast between the inflationary backdrop in China and Japan. In 2020, the Chinese authorities forced property developers to start reducing their high levels of debt, and they have since reported declining profit margins. Bloomberg reported that 18 out of 38 state-owned property developers listed in Greater China reported losses in the first half of 2023, compared to 11 last year. The slowdown in the property sector has had a knock-on effect on the wider economy and financial markets, with falls seen in both annual producer inflation (-4.4%) and consumer price inflation (-0.3%) in July.
As China worries about deflation, Japan welcomes inflation. After three decades in a deflationary environment, Japan reported core CPI of 3.1% and headline CPI of 3.3% in July. While we don’t have any single country funds focused on Chinese equities, we do hold some exposure within our global funds. We also see opportunities in Japan among its high-quality companies that are worldwide household names, such as Sony, Toshiba and Hitachi.
What it all means for our asset allocation views
We think US and UK government bonds are a useful risk management tool. Short-duration bonds look attractive given the yields on offer following historic rate increases by central banks. However, given the uncertainty in the macroeconomic environment, we think long-duration bonds could offer some protection in the event of a market shock.
At atomos we make decisions about our clients’ portfolios based on rigorous research. Overall, our view remains that, globally, economies are unbalanced following a series of shocks starting with the pandemic. Inflation is far too high in many places and how quickly it falls, and what happens to economic growth in the meantime, is the macroeconomic question of the moment. Economic turning points are tricky to forecast and invest through. We think keeping portfolios diversified, using strategies to protect against losses, and investing with skilled active managers is the best strategy to guard against the unexpected.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and is not guaranteed. Investors may not get back the original amount invested.