Welcome to the Inflection Zone

When I turned on Sky news at 6.15am on the day of writing this, Friday 6 September, the news story running was about the US non-farm payrolls for August being announced later in the day. It is the best monthly guide to the jobs market in the US and therefore the strength of the economy. A strong jobs market indicates a strong economy.

You may remember a disappointing number for July was announced at the start of August. That was part of the reason for the sharp fall in stock (equity) markets.

We are at a point (or rather phase) in the global economic cycle when investors are very sensitive to economic data and central bank policy on interest rates. This is sometimes called an inflection point, but it is never a single point – it always takes a period of time to work through.

In essence inflation is under control (or looks to be) and economies are slowing, both of which are a function of higher interest rates. As a result, it is expected that interest rates will fall, and it is already happening in many regions. This is to avoid the risk of economies slowing too much and heading into recession. It is a balancing act that central banks need to achieve, and it’s a difficult one. Recessions are damaging to economies and mean the profitability of many companies suffer, which is generally bad for stock markets.

So, we are scrutinising every release of economic data in every region for clues. The major fear is that interest rates are kept too high for too long, or don’t fall fast enough. We saw in August what can happen to markets. Equity markets in the US and Europe are lower again as the non-farm payroll number wasn’t as good as hoped. We also had Eurozone economic growth data which wasn’t so good. On 11 September the US inflation rate will be announced, on 12 September we will find out if interest rates in the region will be cut again, and the following week we will hear if interest rates in the US and UK will change.

Believe me, there are many, many other “key” data releases as well. One of them or a group of them could cause more market volatility while we go through the “Inflection Zone”. I think we will be in the “Zone” until there is more certainty that interest rates are falling steadily, which could be the rest of this year.

However, the longer term looks to be set fair and long-term investors should not overly worry about the short term. Also, volatility in share prices does provide opportunity for the active investor.

Just when I was getting excited…

The Budget has been a big feature on the UK political calendar for as long as I can remember. There are TV crews and photographers outside No. 11 Downing Street, bets made on how long the speech will last and parliamentary rules allow Chancellors to drink alcohol as they set out their spending agenda. All very quaint, but they are important events. Not so much for hearing about personal tax changes, alcohol duties or car tax, but much more for the overall spending plans of the government.

In the last few years, except for COVID emergency measures, they have been less interesting. However, I sense the Budget on 30 October may be more newsworthy. Of course it is possible we will have had all the measures leaked before then so we are “let down gently”. Either way, overall I think this Budget is much more important than any we have seen for a long time.

In the run up to the election, my view was that there was not an awful lot either party could do on economic policy post-election. That view does not seem to be correct now. The government has committed to spending plans that need to be funded. That funding looks like it is going to come from an increased tax burden on the wealthier element of society. In principle that is fine, but there are clear issues with that.

The government is, encouragingly, keen on growing the economy, but their spending plans are not growth orientated and higher taxes do not lead to growth, they are more likely to reduce it, particularly when they are aimed at a socio-economic group that typically does generate growth at both a personal and business level.

Of course, plans can change, and I could be wrong, and does this really matter in the short term? Well, for UK financial markets, I think it might, a bit.

Following the election, in this note I commented that the stars had aligned to make the UK equity market attractive for investors again, after a long period of being shunned. It looked good value by international and historic comparison, inflation had collapsed, economic growth was better than expected and the political backdrop was stable. All that is still the case, but concerns over the Budget may overhang for a while.

However, we can still find a very large number of companies we want to invest in.

Neil Birrell

Chief Investment Officer