Recent quarterly updates from UK fund managers paint a slightly more favourable picture than you might expect. True, negative market movements continue to weigh on assets under management, but retention rates provide cause for optimism. And research from Bowmore Financial Planning shows that almost half (47.9 per cent) of all money paid into UK individual savings accounts (Isas) is now put into stocks and shares Isas, up from 33.2 per cent in the previous year, and the highest level since the global financial crisis.
Uncertainties have stalked capital markets through much of the year, both in terms of geopolitics and the direction of US bond yields. Central bankers remain hawkish, so the trajectory of the latter will continue to have a major bearing on the valuation of all other assets, including equities, but it pays to remember that the market is not the economy, especially if you wish to avoid cursory investment decisions.
The initial estimate of UK gross domestic product (GDP) for the September quarter showed a fall of 0.2 per cent. The figure, produced by the Office for National Statistics, was better than many economists had been predicting and the contraction was exacerbated by the funeral of Her Majesty Queen Elizabeth II – a one-off if ever there was one.
More tellingly, however, output declined from every manufacturing sub-sector, while real household expenditure fell by 0.5 per cent – hardly encouraging auguries for the remainder of this year and into 2023. If the Bank of England’s (BoE) forecasts are to be believed, the UK could be facing its longest recession since records began.
Much depends on energy prices and the sterling/dollar rate, but even if the latest quarterly figures do herald a prolonged downturn, we shouldn’t forget that investors usually turn bearish well in advance of any economic slump. That’s because economists tend to favour historical data when measuring the health of the economy, whereas stock market valuations are predicated on all currently available information – theoretically, at least. But even if you do buy into the efficient market hypothesis, it still makes sense to take account of how markets reacted in response to previous economic cycles.
The UK is experiencing a more pronounced reversal than its counterparts in the G7 group of developed economies. The probable duration and severity of the downturn is difficult to gauge, but the UK’s deteriorating economic prospects have been reflected in the performance of the domestically-focussed FTSE 250 index since September 2021. Peak-to-trough, the index lost 31 per cent of its value, and although we have witnessed a strong rally since midway through October, history suggests that the rapidity of the run-up means it is probably unsustainable – a dead cat bounce, if you will.
Regardless of where the index is headed in the near term, it’s instructive to note that the stock market had clicked into reverse nearly three months before the BoE made the first of its eight successive base rate increases.
Are there any lessons for investors? Well, if you’re thinking about pulling your risk-based asset allocations from the index, think again. Even if you believe that the BoE is now on autopilot regarding the base rate, that assumption has already been baked into valuations. Admittedly, however, some other areas of the UK economy, most notably the labour market, have yet to influence valuations to the same extent, but there is every chance they will as we move through 2023.
The labour participation rate is still below its level immediately prior to the pandemic lockdowns. This is due to a surge in early retirements and an increase in the number of people suffering long-term health problems. Yet recent research from KPMG and the Recruitment & Employment Confederation indicates that the number of people hired into permanent new roles fell in October for the first time in 20 months. The overall unemployment rate remains at a multi-decade low, but investors should keep one eye on the rolling number of job vacancies as the stock market tends to respond positively to news of rising unemployment in expansions, and negatively in contractions.
A related point worth considering is that we are yet to witness the full extent of inflation-linked pay increases. Rapidly increasing wage costs for employers hinder job creation. Government policy certainly isn’t helping matters in this area. An extended freeze to the lifetime pension allowance acts as an incentive for people to exit the workforce if they’re in danger of breaching it, but it also reduces their marginal propensity to consume, while indirectly increasing wage costs for employers.
If you’re thinking about taking advantage of the index-wide markdowns of the FTSE 250 constituents, whether through stockpicking or passive strategies, it would be advisable to monitor underlying trends within the UK labour market, at least through the first quarter of next year, as the “discount mechanism” will probably trigger any related stock market volatility long before official government figures shed light on the subject.
