The House View Summary:
With our Celtic Samhain festival over for the year, the real horrors of the world are laid bare, flashing on our screens as we enter November. Coming towards the year end, we have one eye on the investment journey of the past 10 months and one eye on where we may end up at the end of the year.
In October, EU Inflation as measured by the Harmonised Indices of Consumer Prices (HICP) continued its downward trajectory from an average of 4.3% to 2.9% with a range of -1.7% in Belgium to 7.8% in Slovakia. Ireland followed suit with lower inflation (5.0% to 3.6%) in the same period. All this points to ECB interest rate policy, with interest rates unchanged at 4.5%, being effective in impeding inflationary growth and indeed, successfully rolling inflation back towards the desired 2% rate which is the goal of the ECB monetary policy.
This is a far cry from the start of year when we experienced an inflation rate of 9.2% in the EU and 8.2% in Ireland. Noting, of course, that like coastal erosion, inflation erodes “permanently” the value of money over time; our €100 today will no longer buy us the same basket of goods as this time last year.
Jumping across the pond to the US, we note a smaller reduction in the rate of inflation from 3.7% to 3.2% and like Europe, the Fed funds rate remained unchanged at 5.5% for the November meeting, a portent that perhaps, progress was slowly being made towards the 2% acceptable rate. However, some commentary emerged from a few Federal State Central Bankers, around a further increase in the FED rate by another 25 bps, something which will be addressed as the data emerges. Raising the FED rate further will depend on how core inflation will behave to the sustained higher interest rate environment. This is anything but trivial and given the US is at near “full” employment, will be more difficult to gauge in the coming months.
Looking forward to next year, both the ECB and Fed have expressed a desire to hold interest rates higher for longer, something which will no doubt hamper earnings growth on the equities side. I came across a very interesting chart recently which was published by Research Affiliates, regarding US interest rates. The chart shows the Federal Govt interest payments (in blue) versus the National Defence, Consumption & Investment are now almost aligned, in other words, the US government is now paying interest at the same level as is allocated to the huge defence budget, (ca. €1Tn per year).
Turning to US Treasury yields, we are now starting to see changes in the yield curve dynamics. The 2 year and 20 year bonds are now yielding 4.83% and 4.82% respectively and the 5 year and 10 year bonds are yielding 4.43% and 4.45% respectively. These yields are all down since September indicating that the bond sell-off in US debt is probably close to being over.
Finally, we are seeing that Oil prices, having hit the lofty early $90’s per barrel earlier in the year have for now returned back to $81 per barrel (at time of writing) a swing in correction of ca. 11%. No doubt, Middle East dynamics, OPEC plus and the war in Ukraine, could still threaten supply, but supply chains to the developed economies for both crude Oil and natural gas have been re-engineered over the past 12 months and stocks have been replenished ready for the coming winter months.
So, economics aside, what does all this mean for investors? Year to date, returns from global equities markets are ca. 13.7% which is down by ca. 9% from the July high of 15.1%. European Equities have recovered their recent shock in September to deliver ca. 9.4% since January, while US equities have delivered ca. 16.3% and Japanese equities have delivered 11.2%, all in Euro terms. These are increases from the September numbers and show a return of confidence in risk assets.
Looking forward, we are seeing forward price / earnings ratios continuing their reversion to long term averages with global equities trading at 15.4 times, European equities at 11.3, Japanese equities trading at 14.1 and US equities trading at 17.3 times their earnings. These are all lower than their seven month averages indicating that (apart from the magnificent seven) equities globally, are trading at good to fair value in the current interest rate environment.
The long-term forecast for growth in global stocks has remained largely unchanged at 10.4% with an average yield of 2.3%. This puts the equity risk premium at ca. 5.6%, nonetheless, current conditions still continue to drive fund flows to the money markets which are currently yielding ca. 3.8% and which are a component of many portfolio’s.
As always, we take the long view on Investments and are happy with globally diversified portfolios. In today’s (relatively) high or normal interest rate environment, we continue to see fair value in across global equities (fPE’s falling to 15.4). We have seen a small resurgence in equities driven by the perceived ECB and US monetary halt in future interest rate rises, which may (or may not) come to fruition and the acceptance that rates will likely not fall to any great extent until late in 2024 at the earliest.
Our view, on global bonds has also remained as per last month. As mentioned, the US 10 year treasury is now yielding 4.45%, which is attractive when compared to the average dividend yield of 2.3% for risk assets. Therefore, with bond yields at current levels, and interest rates almost at their forecast apex, this asset class continues to look more attractive, than in recent years. Our cautious view on lower volatility portfolios continues to be implemented through the use of money market funds, currently yielding ca. 3.8% and hedge fund positions to exploit market inefficiencies; all in all, providing some degree of protection in the current volatile climate.
Sources: Central Banks: Federal Reserve, ECB, CBOI, Sharepad®. Euro Inflation is measured by the Harmonised Indices of Consumer Prices (HICP). Periodic Market updates & reading materials from Vanguard, Bloomberg, Ruffer, Davy Select & others depending on subject matter. All views and details contained are for information purposes only, are subject to change & are not advice. We recommend you seek independent clarification for your particular circumstances. Lifetime Financial Planning makes no representations as to the accuracy, completeness nor suitability of any of the information contained within and will not be held liable for any errors, omissions or any losses arising from its use.