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Financial Update from Brewin Dolphin - 17 November 2023

The Weekly Round-up

Friday 17 November 2023

In his latest weekly round-up, Guy Foster, Chief Strategist, discusses easing inflationary pressures in the US and UK and the drivers behind the recent equity market rally.

November has so far been a strong month for the equity market, largely driven by an ebbing of inflationary fears. The most obvious evidence of this decline comes, unsurprisingly, from reported inflation figures. This week, we saw the publication of consumer price inflation figures for both the US and the UK. 

Investors are focused mainly on the US for a few reasons. Paramount among these is the size of the US economy, its bond market and its role as the provider of the global reserve currency. This means that Treasury yields are seen as a benchmark interest rate around the world, and to the extent that they reflect US inflation, any easing of inflationary pressures increases the chances of an easing of interest rates, which would be felt indirectly around the world. 

Inflation statistics

This month, the news has been almost entirely reassuring from the US inflation statistics. Headline prices did not seem to rise at all during October, having been weighed down by energy. The more representative core inflation measure, which strips out more volatile food and energy prices, rose at a slower pace than previously. Even so-called ‘super core’ inflation (core services less housing), which aims to capture those elements of inflation that would be most directly impacted by the tight labour market, slowed. A core annual inflation rate of 4% would seem shocking under normal circumstances, but having declined from 6.3% a year ago, the progress is tangible and reassuring.

The UK data was similarly reassuring. The UK has been one of the worst-afflicted developed markets from an inflationary perspective and the decline has been a long and arduous one. This partly reflects the way in which utility bills are regulated in the UK. This slowed the pace of increases and meant they stayed higher for a protracted period of time, but October’s inflation data finally saw the most significant increases dropping out of the annual figures. As in the US, inflation in the UK remains too high, but it is much lower than the 11% it reached in October last year. Things are moving in the right direction, but there is a long way to go. The fact that the sharp increases related to utility bills have now dropped out of the annual numbers means that future declines will need to come from other sources.

A lot of the increase in consumer prices stemmed from the high demand for goods from cash- and time-rich consumers, who were locked down in their homes while Covid circulated. It was compounded by supply chains which were interrupted by manufacturing and logistical disruptions, also caused by Covid. 

Both these trends have materially eased. The remaining factors would be services demand, which bounced back sharply, and services supply, which recovered more gradually due to difficulties attracting enough staff. So, consumer demand and employment have become the critical factors to watch from an inflation and growth perspective.

Easing US labour market

We discussed the gradually easing US labour market after the October employment data was released. Jobless claims data released this week seems consistent with lower labour demand. There was also some weakness in housebuilder sentiment and industrial production, all of which supports the idea of generally weakening demand and gradually weakening price pressures.

The market reaction was a very strong rally in most bond asset classes, which also spread into equities. This has transformed the technical picture from one which was in danger of developing into a pattern of lower lows and lower highs into one that is far more ambiguous. Within the equity market, the rallies have been driven by those assets which are perceived to be the losers from higher interest rates. Those can be growth stocks (which are interest rate-sensitive because they are expected to generate value far off into the future) or quality stocks (that have very stable cashflows). It also included some distressed assets like speculative growth companies or indebted real estate assets.

The ‘Magnificent Seven’

A common theme that remains in place is that the seven stocks which have dominated the global equity market this year are benefitting again from lower bond yields. Six of the seven have outperformed the broader equity market and all of the main underlying equity market factors. A word of caution is that the speed of the market reaction does not necessarily bode well. Upside moves in the equity market can be driven by technical factors, such as the squeezing of short positions, rather than purely reflecting a more benign economic outlook.

The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.


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