If it was ever necessary, the last few weeks of the quarter have provided an object lesson as to why quality does not matter until it does, in a quarter that included emergency measures and bank bailouts across the US and Europe. Over the past 18 months, the US Federal Reserve has rapidly raised the Fed Funds Rate from close to 0% to almost 5% in response to the highest levels of inflation in 40 years. This has been the second most aggressive Fed hiking cycle in history, after only 1980. These moves have led to a number of intended and unintended consequences. Barring any sudden inflationary shocks, it seems reasonable to think the US and UK are closer to the end of their rate tightening cycles than the beginning. However, we have now witnessed the impact of rising interest rates across the banking system, where fault lines have been revealed and policymakers may now take time to pause and review the effects on economies.
We have come to an end of an era in which capital was practically free. The impact of rising rates has yet to be fully felt across the UK economy, as mortgage holders come off their current fixed terms they will have to refinance at much higher rates. We do not believe we have seen the impact of this in consumer spending yet. Nor have we seen expensive corporate debt result in more business failure and resulting higher unemployment. Historically, these tend to be lagging indicators of the effects of rising interest rates. The UK labour supply is tight, but the economic risks remain, as does our caution.
Year to date, index returns have reflected an aversion to risk (Gold +5.8%) and expectations of a peak in rate rises (FTSE All Gilt Index +2.1%) as fears of a slowdown in the West compete with improvements in economic activity in Asia. The technology heavy NASDAQ has also posted a better relative return versus other equity indices ( +18.2% ) and I believe that the biggest, cash rich, debt free technology companies blessed with monopolistic qualities are an attractive haven in a world of scarce growth and higher debt servicing costs. Within the technology sector, generative Artificial Intelligence (AI) is both an opportunity and a risk. Microsoft and Alphabet are leading the innovation in AI which will drive demand for ever more powerful semi-conductors and cloud storage. These high quality businesses, alongside well-run technology funds, offer exposure to this area of growth.
Equity markets do not yet appear to be fully discounting the effects of tighter monetary policy on consumer spending, and in turn on corporate earnings. Remaining focused on companies that have sustainable competitive positions, in expanding growth markets, coupled with management teams that have a record of value creation and strong company balance sheets to weather any kind of adversity, continues to be the focus. These criteria lead us towards companies with exciting growth prospects that are involved in digital transformation, consumer products, healthcare and life sciences, and those at the forefront of the sustainable energy transition.
Charles Bathurst-Norman, Investment Director
The value of securities and their income can fall as well as rise. Past performance should not be seen as an indication of future results. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
