This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.
We also provide regular webinars called “Making Sense of Markets” where they discuss the factors affecting economies and markets. Our most recent webinar was held on 6th May. Please click here to watch the recording.
In this latest market update we discuss the Bank of England’s interest rate decision, how the Iran war will affect the path of inflation and what the fate of Keir Starmer could mean for markets.
Interest Rates
Last week the Bank of England held interest rates at 3.75% in a widely expected decision. While the start of this year saw investment markets expecting further interest rate cuts, current expectations are now of rate hikes. Whether these materialise or not will in large part be determined by the path of the Iran war and the flow of oil through the Strait of Hormuz.
In the Monetary Policy Report, which was released alongside the interest rate decision, the Bank’s Monetary Policy Committee provided three plausible scenarios that could materialise over the coming months and years. The most moderate of these, Scenario A, would see inflation peak below 4% as energy prices experience a short-term spike, while in the most extreme, Scenario C, inflation is predicted to peak above 6%, as energy prices remain high for an extended period, leading to inflation expectations spreading across the economy, as occurred following the 2022 Ukraine and Covid-linked surge in prices. In each of these situations, interest rate decisions would differ.
As such, the Bank of England is effectively saying that they don’t know where interest rates will go from here. This is not to say the Bank is failing in their duty, but rather an acknowledgement that with the most pressing matter in the global economy being a political issue, this cannot be accurately forecast by economists. The path of interest rates will depend on the path of this war.
Market Reactions to Iran War
Markets fell in value during March this year, as the Iran conflict developed and energy prices surged. April was more buoyant, as the initial two week ceasefire showed a desire for resolution which then morphed into an open-ended ceasefire. The most recent fortnight has shown a repeat of that trend, with European markets falling as a deal looked far off, followed by a strong rally yesterday as the outline of a peace deal was proposed. This tale may well twist again, but it shows the direction markets will likely take when a lasting deal is eventually struck.
Despite being bombarded by superior military powers in the US and Israel, Iran has played a strong hand throughout the conflict by proving its ability to close the Strait of Hormuz, which for decades previously had been merely an untested threat. This therefore gives it leverage in negotiations with the US over how to settle the conflict. Nonetheless the country is suffering from the blockade of its ports and now with China urging it to find a negotiated settlement, it is incentivised to find peace.
Desire for a Deal
From the US perspective, it appears that President Trump has underestimated his adversary, perhaps overconfident from his success earlier this year in achieving regime change in Venezuela. It also appears that he now seeks an exit from this conflict. While Trump claims that the US is unaffected by a closure of the Strait as it is self-sufficient in energy, in our globally connected economy, American consumers are also affected by higher energy prices, which is most visible in forecourt petrol (gas) prices.
Donald Trump’s MAGA movement has traditionally been against interventionist wars, while his popular criticisms of Joe Biden focused on the high inflation of his predecessor’s term. Trump is therefore seen to have reneged on both promises and this looks likely to be damaging for Republican prospects in the US mid-term elections in November this year. While Trump himself will not be on the ballot paper, should Democrats gain power in Congress, this could significantly limit the president’s power in his remaining two years in the White House.
As such, it appears that a peace deal could suit both parties. The timing of this cannot be predicted with confidence, it may be within a few days, or it may take a number of months. But an eventual resolution seems the most likely outcome.
Market Outlook
What this means for investment markets, therefore, is that a return to economic considerations, as opposed to geopolitical concerns, is likely, and so an assessment of the risks and opportunities here is warranted.
High stock market valuations were part of the recent warning of the Bank of England Deputy Governor, Sarah Breeden. She listed a combination of factors that, if they simultaneously materialise, could lead to large losses. Valuations, however, vary across regions and sectors and while predominantly US based AI stocks look overvalued, areas such as the UK, Asia and Emerging Markets are at fairly average valuations, despite headline prices having recently been at all-time-highs, given that profits have been high. Europe and Japan are slightly ahead of average, but well within typical ranges. It is primarily the US which looks excessively stretched.
On the positive side are the reductions in interest rates we have seen over recent years, the fiscal stimulus coming from US tax cuts as well as German defence and infrastructure spending, and the strong corporate earnings results we have seen over recent months. Despite the geopolitical strain, profits have been rising, with factors such as AI productivity gains now helping companies across the wider economy, and not just the handful of tech giants that have thus far been the primary beneficiaries of this technological development.
Moderate inflation, often viewed negatively, can be beneficial for markets if kept within a manageable range. It supports nominal GDP growth, revenue expansion, and pricing power for companies. This environment can be constructive for equities, provided inflation does not spiral out of control.
In managing these considerations for investment portfolios, the short-term is likely to remain volatile until a lasting resolution regarding the Strait of Hormuz is found, but over the medium-term there are reasons for continued optimism. While few equity areas can be described as ‘cheap’, ‘fair value’ opportunities can be found and growth prospects remain. Within bond markets, exposure to longer-dated debt is at risk from rising inflation and expanded government borrowing, yet short- to medium-dated debt is better positioned on a global basis.
UK Elections
A final point to discuss is the prospects for Keir Starmer. With Labour expected to do poorly in today’s elections, the question is how badly it will do. Discussions of his departure from 10 Downing Street have been an important factor in the rising cost of borrowing for the UK government. Markets would likely be happy with someone from the right of the party, such as Wes Streeting, but leading candidates to the left, such as Angela Rayner or Andy Burnham, would likely be poorly received, with borrowing costs rising.
Globally, this is a relatively unimportant question, and for internationally diversified investment portfolios, this is only one aspect to consider. Yet, for the prospects of the UK economy and for UK based businesses, this will be a subject that should be carefully monitored.
Our Investment Philosophy
Volatility is a part of investing, which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fare better in different market conditions as they are more defensive assets, such as bonds, whereas during periods of growth, equities tend to fare better.
Armstrong Watson, in addition to our full range of accountancy services, also have our own fund management service, Future Money. This team provides investment and economic expertise which, alongside additional sources from the wider market, enable us to provide insight, commentary, advice and support to our financial planning and wealth management clients.
A key aspect of our investment philosophy is that it is time in the market, not timing the market, which is usually the best approach. For more information and guidance on investing, please download our useful Introduction to Investing here.
Important Information
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.
If you would like to discuss your investment portfolio please speak with one of our Financial Planning Consultants on 0808 144 5575 or email us.
