September 2022

“Failing conventionally is the route to go; as a group lemmings may have a rotten image, but no individual lemming has ever received bad press.”  Warren Buffett

Having collectively spent the last 18 months with the heads in the sand about the looming inflationary crisis central bankers went full circle in attempt to channel their inner Paul Volcker to slay the monetary dragon.  Like inebriates at a whiskey auction each has now sought to outdo the other, with every public utterance bringing pledges of bigger and bigger rate increases.  “Lower for longer” has become “Don’t stop me now!”, raising the spectre of a hard(er) landing in the next year.  As previously mentioned, the situation in Europe is particularly perilous with little economic momentum and an omnipresent risk of a debt sustainability crisis developing with higher rates.  This, even as data increasingly show signs of slowing, as past hikes have started to affect housing and other sensitive sectors, while falling shipping rates indicate easing in supply chain strains.  Where to from here?  Almost regardless of data it seems that central banks have committed to at least another large hike in the next set of meetings.  The betting here is that markets may at that point start to factor in a pause.

September also brought politics to the fore.  Elections in Italy provided no surprises for a change and despite the significant shift in direction for the new government market reaction was fairly relaxed.  The same was not true in the UK, where the new leadership brought forth a radical “mini-budget”, centred on low tax/pro-growth measures.  Immediately there was a severe reaction in GBP markets with long-dated gilts widening by as much as 200bps at one stage before intervention calmed matters.  The budget also spawned a mutinous reaction among the Tories, who always display a special skill for the arts of civil war and threatened to overshadow their party conference.  There was also an international reaction led by the IMF, an organization whose sole role these days is to provide sinecures for former European politicians, and which had stayed silent as trillions of dollars of unfunded spending permeated the global economy creating the very problems plaguing us today.  Clearly, no dissent from the high tax and spend orthodoxy will be tolerated.

The net result of all that was a torrid time for risk markets.  The SPX fell 9% back to the lows of the summer while bond yields backed up 50 to 70 basis points while the USD reaffirmed its strength.  Technology shares were particularly weak as the meltdown of SPACS reached a crescendo and signs of contagion were present as liquidation fuelled selling in credit markets, already unsettled by rate moves.  All of this resulted in the fund’s A shares falling -1.27%, driven by the sell-off in bonds at the end of the month. Credit had a negative -157bps contribution in gross performance while equities contributed a positive +34bps.

And so we head into Q4 against a backdrop of unsettled markets with a cloudy economic outlook.   Earnings releases will highlight what we believe will be strong performance from core banking businesses but weaker results from universal banking models, with M&A and capital markets’ activity dramatically lower.  But it is almost certain that central bank activity will be the focus of attention while all economic data will be parsed for signs of slowing.  At this stage credit securities are discounting a considerable amount of future bad news but we will need to see greater clarity around rates and a reduction of volatility for confirmation.  Could escalating volatility be a catalyst for central bank action?  Almost certainly if there is a threat to market integrity.