October 2022

“It’s not evil that’s ruining the earth but mediocrity.  The crime is not that Nero played while Rome burned, but that he played badly.” Ned Rorem

The ignominious end of the buffoonish Roman Emperor Nero’s reign famously led to the “Year of the Four Emperors” in 69 AD, a time marked by duplicitous scheming and great volatility.  In an echo of that time the UK has had its own period of extreme political turmoil following the downfall of a narcissistic PM.  Following on from last month’s budget-induced fiasco Gilt yields soared prompting forced selling by Liability Driven Investment (LDI) funds who had taken Archimedes advice about leverage too seriously, which in turn fuelled a Tory (PraeTORYan?) revolt that led to the downfall of the Truss premiership.  Soothed by further BOE intervention markets stabilized somewhat and by the end of the month new PM Sunak had been installed with a pledge to deliver more sober policies.  Back to the bread and circuses for the mob.  In the meantime, controversy continued to swirl around cabinet selections as multiple lapses of personal judgement were a further signal that this is a regime well past its salad days.  The turmoil of the year 69 served as an interregnum between the Julio-Claudian and Flavian dynastic eras.  Is this a portend for another epochal shift in the British political landscape in two years?

Elsewhere there was much continued volatility in markets which remained focused on central bank policy.  Predictably the ECB raised rates 75 bp, which was taken in stride, while US debt markets were looking for signs of a pivot/pause in policy.  The dilemma is that the US employment remains fairly strong even as forward-looking indicators are pointing to an economic slowdown.  What will be the ultimate catalyst to spark a pivot?  Judging by the unrelenting number of Fed speakers on display and Chairman Powell’s comments about the recent rally, one might also conclude that the Fed is keenly trying to motivate equity markets lower.  On the other hand, reducing the wealth effect by lowering asset values while simultaneously putting debt-financed spending money in people’s pockets might not be the “Whip Inflation Now” strategy that policy makers might believe it to be.  Fuelling demand while chilling supply may well result in more stagflation, which in turn might require credit conditions tightened to the point where the current “rolling recession” becomes a hard landing.

For the moment markets remain unfazed.  The SPX rebounded 8% against a backdrop of rising but more stable yields, while European financial equities also saw a similar rebound as the first Q3 results continued to show net interest income gains thanks to higher rates, and so far no signs of stress from borrowers.  European rates were more volatile, reflecting a lack of consensus over specific ECB intentions and the greater risk slowdown.  This in turn fed through to bank credit, where interest rate uncertainty and some contagion driven selling kept buyers away.  The overwrought drama taking place at Credit Suisse, which saw exaggerated fears of a “Lehman moment” drive credit spreads wider also contributed to the mixed environment. AT1s showed signs of bottoming out from the beginning of the month and finished overall higher, but trading remained nonetheless choppy. For the month, the fund’s A shares fell -1.7%, reflecting protracted weakness in some of our second-tier bond holdings. Credit overall had a negative -189bps impact on gross performance, while equities contributed +20bps.

As we look forward to the balance of the year and beyond, we retain a high degree of conviction in the portfolio.  We have used select moments of weakness to trim short positions but we retain dry powder to commit opportunistically.  From a timing perspective we are almost certain to see one final large hike in official rates before a shift in policy is likely.  We believe this pivot will come in the first quarter of the new year.