It feels like a constant mantra when I sit to write a new article but I hardly know where to start this week. So much has happened that I feel as though I could almost write an article a day and still struggle to keep up with events.
Rather than try to dissect all the economic events of the last few weeks, I think it is more sensible to say that the speed and discordance of events are making it increasingly difficult to sensibly forecast. We have political turmoil, bond market shocks, sky high inflation, rising interest rates, and an on-going energy crisis – the speed and convergence of these events is such that sensibly predicting where we will be by Christmas, let alone this time next year feels almost impossible.
One huge shift in narrative seems to be that markets have suddenly decided that endless deficit spending and rock bottom interest rates are no longer the order of the day. As a result, the UK Government has been caught on the back foot and is now scrambling to fill a fiscal hole worth tens of billions in our annual budget.
The spiking yield in UK gilts meant that for the first time in years, I decided to shift some of my cash position into them – although they’re still losing money to inflation at current rates, I’m expecting inflation rates to fall towards the back end of next year as unemployment rises and the UK households, business (and seemingly the government too) all pull back on spending. When bonds were paying 1-2%, the opportunity cost seemed minimal, but after locking in a yield of 4.2% on a tranche of gilts, I feel they provide some welcome yield to a cash position that has previously been dead weight in my quest for income.
My overall portfolio has been recovering slightly over the last few weeks in a surprising turn of events. Although my losses are still double digit (around 15% at the time of writing), this is better than the 18% I was facing a few weeks ago and better still than the 22% drawdown I hit in the immediate aftermath of the mini-budget.
If anything, I feel like the Bank of England and UK Government are seriously struggling to keep control of the narrative this year. Although I’m generally wary of taking economic commentary from Twitter, my feed seems to be filled with people who want the government to ignore the deficit and fiscal gap and just keep spending like to tomorrow to prop up the economy. Despite this, these are the same accounts that only a few weeks ago were howling with rage when Liz Truss did just that and tanked both the pound sterling and gilt market. Of course, the goal was different and apparently if we deficit spend to support consumers rather than fund tax cuts for the rich we’ll be fine, but honestly, I’m not so convinced.
This does, however, leave us in the unenviable position of raising interest rates into a weakening economy. Unemployment is now being forecast to double, the pound continues its multi-decade trend of weakening against the dollar, and most industry commentators are now forecasting a 10-15% correction in house prices. As a result, economic confidence in both the Bank and Government is poor and Andrew Bailey comes over as totally tone deaf when discussing the economic reality most of us find ourselves facing.
Against this backdrop, I have the uncomfortable sensation of feeling like the economic tapestry of the country is coming apart at the seams. Many of the large-cap names in the market have suffered a crunch and small-caps have been decimated. This means that when I look around the market, I can see lots of names that appear to be high quality and low price; surely a great combination?
The problem I face is that I have little confidence that low prices will not go lower. With the Bank of England unwinding Quantitative Easing, interest rates climbing at a rapid pace (a just 3% we’ve now had eight consecutive rises and if anything this trend looks likely to accelerate). Andrew Bailey is indicating that markets are expectant of interest rates going higher than he thinks they need to, but considering his appalling track record thus far, I have about as much confidence in him and his team at this point as a random number generator.
A second challenge is in trying to get an accurate feeling for prices across the economy. On a personal level, I am now actively checking my expenditure in a way I haven’t had to do for years. As a creature of habit, I have predictable outlays which I could historically manage comfortably but in the last twelve months I’ve found myself increasingly concerned about energy use and grocery bills, noticing rapid and persistent inflation in both.
I wouldn’t say I’m struggling – I’m fairly well renumerated at work and am fortunate to have optionality in my expenditure, but I can easily see how lower income families must be feeling increasingly intense financial pressure as the months tick by.
And where does all this leave me in terms of investing?
I’d describe my mentality as ‘cautiously acquisitive’. The rational part of my brain can easily spot fantastic quality companies at good prices in this market; unlike this this time last year, I’m not scratching my head trying to find companies at prices I like. Having said that, I’m also well aware of the economic headwinds we face, not just in the UK but around the world, and as a result am being put off making many large-scale acquisitions.
A great example is Microsoft, a company I’ve watched for years and really like. This time last year, the company was priced at about $340 a share, and after running a few pricing models, I set a rough target of about $250. Well, sure enough, the company hit by June of this year but I found myself feeling like it had further to fall. Needless to say, it did, and is now hovering around the $220 mark, over a third down from it’s all time high. The problem is that I think the company still has further to fall.
Interest rates continue to climb, inflation is still high, the energy crisis is far from over and so the company finds itself operating against a less than ideal economic backdrop. On balance, do I therefore think this company will be cheaper or more expensive in the next six months…honestly, I think it will be cheaper!
At this junction, most experienced investors tell you this is a good thing – buy a little bit now and if the price comes down further, buy some more when it’s cheaper. The idea of averaging down sounds great on paper but it depends how far towards the bottom of the trough you think we are. At $250 a share, the company looked about fair value to me, and at $220 a share, it’s starting to look undervalued.
The company has changed significantly over the last 20 years but is an undeniably core part of our global IT infrastructure. It has remarkably stable earnings, having had only two years of EPS declines in the last twenty (2009 and 2013) and has grown it’s EPS every other year. This has meant the company has usually had a relatively robust P/E in the low to mid 20s.
The problem then becomes that although the past can inform the future, it is no guarantee of it. The world of 2023 is not the world of 2003 and so Microsoft may be one of those companies that finds it increasingly difficult to manage costs in our persistently inflationary world. Certainly, many of their products are required for the modern world to operate but is it impossible that if things get bad enough the world will have to make a choice about prioritising energy and food stability over software and systems?
This narrative applies to a great many companies available at good prices today. As such, my outlook for public markets remains tepid at best until inflation is nailed to the floor again.
Thankfully, I’ve read enough material to also believe that “this too shall pass”. Over any fifty year period the amount of ‘bad news’ an investor could choose to act on is astonishing. Over the last fifty year period, we’ve had two periods of sky-high inflation, multiple wars including Iraq, Iran and now Ukraine, political turmoil, a sovereign debt crisis, a credit crisis, a banking crisis, a pensions crisis, and an energy crisis. We’ve had the US government shutdown, the COVID pandemic, the Y2K panic, the dotcom bubble, terrorist attacks and more recessions than I can count.
My point is not that any of these items together or in isolation were unimportant or insignificant but rather than when it comes to investing there has been money to be made throughout. Markets and economies don’t really care how you feel at any given moment although in the short-term their direction is often more determined by sentiment and momentum than fundamentals. Over the long-term, however, buying good quality companies at good prices and letting them do their thing is a proven record for success going back hundreds of years.
I am, therefore, a \”cautious purchaser\” at the moment – if I like Microsoft at $250, then I like it even more at $220 and I’ll love it at $200. Am I saying Microsoft could go to $200 then? Yes. I think it could go even lower if current market conditions keep up the way they are. It is tempting, after 18 months of increasing volatility, to convince yourself that inflation is starting to roll over, but I would rather wait for it to have rolled over for certain before I start trying to guess whether it will be higher or lower in another six months.
By this, I mean that until both the UK and the US see inflation meaningfully pulling back, I do not believe we will not see public markets begin to stabilise. Even if our inflation rate halves we would still be over 5%, and that is after a year of it increasing over 10%. By that point, however, I believe Central Banks would feel sufficiently confident to ease up on rate hikes, calming markets. Many people I know believe this is coming but they’ve been saying it for months and still inflation continues to climb.
One investor I like refers to investing being much like “skating to wear the [ice hockey] puck will be, not where it is right now”. The thing is, by ignoring where the puck is right now we can easily miss obvious warning signs that cost us money further down the road. Even if I believe that inflation is due to fall imminently it is not currently falling. Until that statement changes, I think the global economy, consumers and businesses are in for more choppy waters.