October 2023

“Only government can take perfectly good paper, cover it with perfectly good ink and make the combination worthless.”  Milton Friedman

Government bond yields were the main market topic of discussion once again with long term yields both rising and becoming more volatile.  US 10y yields rose a further 35 bp and on several occasions breached the 5% level for the first time since the George W Bush presidency.  Concerns over runaway fiscal spending and the growing realization that higher rates are the new normal overcame softish economic data.  It is worth noting that the topic of deficit spending – on both sides of the Atlantic – will increasingly come under the spotlight.  In the past three years the US increased the debt by $5 Trillion, most of which came with the economy running at a full head of steam.  Over the next few years much of this will need to be refinanced, while at the same time provisions of the 2017 tax reform will expire, pushing up tax rates.  Expect the term “fiscal cliff” to re-enter the lexicon.  Will profligate governments get the message on excessive spending however?   Colour us sceptical, given that slowing economic conditions may create other priorities by then.  By month end, short covering and rising geopolitical risks in the Middle East after Hamas terror attacks on the 7^th led to some safe haven buying.  In Europe, deteriorating data mitigated rising US rates but yields rose nonetheless. 

As expected, the volatility had a negative effect on equities, with the SPX leading the way dropping 2.7% to bring the correction from recent highs to about 10%.  Questions around valuation remain, given that P/E ratios are historically high, especially against a backdrop of 5% yields.    Barring heroic earnings delivery these are strong headwinds for equity markets going forward, particularly high multiple growth stocks.  One might expect that credit will benefit from the stable environment, although it will be very sector dependent.

October saw the first batch of Q3 results for European banks, and as we’ve long discussed in our reports those banks with simple, straight forward business models continued to benefit from healthy NIMs while the universal banks struggled with subdued capital markets and M&A activity.  This is starting to sound like a broken record and predictably there have been announcements of job losses within CIB divisions.  Meanwhile the gap to US competitors continues to widen, which all managed to show much better performance.  The time has come for more radical action from large European banks and not just an endless round of layoffs.  Without pressure from shareholders this is not likely to happen.

For the month, the funds A shares rose +8bps with fixed income contributing just +1bp in gross performance while equities contributed +11bps.  Given the considerable uncertainty we made no significant changes to the profile of the portfolio, instead continuing to tweak exposures to take advantage of individual security price moves.  Looking forward we still believe it is too early to declare an end to this uncertainty, and so will continue with the same approach.  November will bring results announcements from a number of our core holdings, and we expect to see opportunities for action, given that new data tends to be a catalyst for investor reaction.  At this stage in the year, we believe overall conditions for return generation remain very attractive albeit with macro uncertainties.  We are well positioned for this and will actively add risk if the broad picture is clarified.