Vox Weekly Wrap: a big week for central banks

After a sometimes-up-but-mostly-down year for equities, hope appeared to return to the markets in October. In an eerie echo of the dotcom boom and bust, the all-important Nasdaq 100 index had peaked as 2021 drew to a close, losing 37% before hitting its latest low in mid-October. 

But by 25th October it had clawed back 12% on hopes that the Federal Reserve would ‘pivot’ back towards a monetary policy approach that would be beneficial to stocks, and particularly the once highly-rated growth ones that had suffered most during the 2022 sell-off.

London’s markets are not endowed with the richness of large tech stocks like the US, but - resources and defensives heavy FTSE 100 aside - investors in the UK have suffered similarly, whether in the more speculative hunting grounds of the Aim or SmallCap indices, or in the more domestically focused FTSE 250. 

The latter has been hit not just by the effect of inflation and consequential interest rate rises, but by growing concerns about the health of the UK economy. Whilst recessionary pressures are being felt all around the world, the UK is feeling the pinch more than most others, the combination of chaotic politics, import dependence, and a generally imbalanced economy that depends far too heavily on the strength of the consumer. 

Indeed, while London’s markets are a little calmer since the catastrophic Truss/Kwarteng mini-budget that prompted their departures, successors Rishi Sunak and Jeremy Hunt are now faced with the uphill struggle to rebuild the national finances. Tax increases and a return to austerity are on the cards when the Chancellor delivers his Autumn Statement on 17th November, potentially increasing the strain on already stretched households.

Consumer pain

We’ve had lots of data this week that shows just how tough things already are, including the first monthly drop in house prices since the start of the pandemic, according to the latest data from lender Nationwide. The obvious culprit is rising interest rates, with average 2-year fixed mortgage rates more than doubling from a year ago following eight consecutive rate rises by the BoE, including a 0.75% increase this week to 3%, the largest single rate rise since 1989. 

Although the Bank’s governor suggested the market was pricing in too many hikes, even a further rise to a terminal rate of 4% - rather than 6% as had been feared necessary by those in the bond market - is likely to inflict further stress on borrowers. Morgan Stanley has said that 4 in 10 UK households may struggle to pay their mortgages next year when initial terms end, which in turn could see even more significant fall in house prices. 

In its results last week Lloyds Bank suggested that house prices could fall 8% in 2023 under its base case, but could fall as much as 18% under its worst-case scenario - and forecast from other UK mortgage lenders say much the same thing. It’s noteworthy that, such has been the heat in the housing market, even this latter figure wouldn't take prices much below pre-pandemic levels. 

The obvious worry, then, is that given the already stretched affordability of UK housing even these worst case outcomes understate the degree of fragility in the UK market. The BoE may suggest that rates will peak at 4%, but it also warned this week that the UK faces a recession that could last until mid-2024, the longest in 100 years, and which could see the unemployment rate rise from 3.5% to 6.5% and inflation peak at 11% by the end of this year.

As Russ Mould, Investment Director at broker AJ Bell, told Vox this week, the bank may have been attempting to scare the public into spending less to dampen inflation.  

But whether intentional scare tactics or not, it suggests further pain in store for the consumer facing sectors that have so far been hit hardest in the ongoing bear market – retailers, real estate/housebuilders, and leisure. Bargain hunters have been casting their eye over these sectors in recent weeks, but worsening data from various retail sales surveys suggest earnings risk remains high as households batten down the hatches. That becomes vene more likely as the halo effect of a strong housing market dims. 

Fighting the Fed

Whilst the BoE has been doing its utmost to downplay the likely extent of future rate rises, the message from the Federal Reserve this week was somewhat different. Unlike the UK, the US has seemingly managed to avoid an imminent recession so far, which has only given the Fed more scope to fight inflation – the latest ‘good-is-bad’ news being a surprise increase in job vacancies, one of the many lagging indicators that our analyst Paul Hill suggests the Fed is wrong to focus on. 

It too raised the core Fed Funds rate by 0.75% but put pay to any hopes that it would ‘pivot’ away from tightening monetary policy. It suggested that “the ultimate level of interest rates will be higher than expected,” which the market is interpreting as rates peaking above 5% in late 2023.

That in itself would be bad news for equities – a higher risk-free treasury rate has a downward effect on equity valuations as investors demand a higher rate of return for taking on equity risk. And indeed, US equities saw a big intra-day swing as investors realised that they’d misinterpreted the pre-press conference statement as dovish.

But the impact is made all the worse by clear signs of economic weakness making its way through the income statements of some of the markets biggest tech companies - Alphabet’s core search ad business suffered a sharp slowdown, Microsoft warned of slowing cloud computing growth as it missed revenue expectations, while Amazon fell on a week Q4 outlook. The hopeful tone of mid-October has given way to reality. 

Meta, too, has been hit hard by the industry-wide hit to advertising spending – it saw revenues decline 4%, net income slide 52%, and its share price shed another 20%, taking its peak-to-trough fall to 75%. Investors are also worried about where its cash is going, the answer being mainly into Metaverse investments with the jury is very much out on whether they pay off one day.

In the meantime, advertisers’ growing reluctance to spend would also suggest that they’ll be looking for ways to spend more effectively. One answer could be Mirriad’s in-content advertising, which new research suggests increases viewers’ purchase intention by 24%. The cash-rich Aim company said its seeing strong demand ahead of this year’s all-important holiday season. 

You can read our report into the future of advertising and Mirriad's role in it here.

Resources hope

Even as hopes of a Fed pivot are dashed, investors have spotted signs of another pivot which they hope could give equity markets – the end of China’s zero Covid policy. 

An as-yet-uncorroborated report on social media that China is considering reopening its borders and ditching chunks of Covid restrictions has seen the battered Hang Seng index climb 9% this week and China sensitive sectors like mining and oil jump.

The risk is that the rumour is little more than that. But it shouldn’t be entirely discounted, either. Slowing growth is a problem that President Xi will be keen to address as he continues to consolidate power, and zero covid has been huge drag on the country’s economic performance.

We spoke to SP Angel’s mining analyst this week about what’s going on in China, and what it means for metal prices and miners. 

Whatever the case, the world is going to need a lot more of metals as it shifts towards a renewable energy driven economy, not least lithium, a key component of EV and grid level batteries. Here are five UK miners that are likely to prosper as the energy transition gathers pace.