Amidst rising interest rates and gloomy economic forecasts, Rupert Thompson, chief investment officer at Kingswood, discusses the market outlook.

Volatility remained heightened last week. The downward trend also continued with global equities retreating a further 1.3 per cent in local currency terms, now back down to their low on 8 March, Rupert Thompson, chief investment officer, Kingswood Group, said.

The damage for UK investors was limited by a fall in the pound. Whilst government bond yields continued to head higher, 10-year yields broke conclusively through the 3 per cent barrier in the US reaching 3.1 per cent. In Germany, they rose above 1 per cent, a far cry from the negative yields seen in recent years, while in the UK, they are testing 2 per cent, up from a low of zero in summer 2020, Thompson said. 

The big event was the Fed meeting which, as expected, saw rates raised by 0.5 per cent. The Fed also confirmed that it would start quantitative tightening, namely reducing its bond holdings. The rundown will be capped at $95 billion a month, which means that the Fed will be shrinking its balance sheet considerably faster than back in 2018 to 2019. US rates now look on course to be up at around 3 per cent by this time next year, he added.

The Bank of England also raised rates a further 0.25 per cent and it expects inflation to peak as high as 10 per cent later this year, on the back of a further 40 per cent hike in the energy cap in October, before falling back below 2 per cent in two years’ time. 

At the same time, the Bank cut its growth forecasts sharply and now sees the economy flirting with recession over the next year or two. This weakness is a major reason why rates look likely to rise no more than another 0.5 to 1.0 per cent in the UK versus 2 per cent in the US, Thompson added.

The BOE’s gloom may be a little overdone but still looks rather more realistic than the optimism of the Fed, Thompson said. While outright recession may well still be avoidable in the US, a marked slowdown in growth looks certain to bring inflation back under control.

Outlook
The new stagflationary environment leaves the outlook for markets looking more challenging. Prospective returns should be markedly lower than in recent years, particularly in real terms. That said, equities, along with other real assets offering an element of inflation protection, should see gains with the cheaper/higher quality areas offering the best opportunities, he explained. Indeed, despite all the gloom and doom at the moment, US earnings have beaten expectations in the current reporting season and should be up a healthy 10 per cent or so on a year earlier, he added.

Equities certainly look better placed than bonds where yields should continue to trend higher while monetary policy is still being tightened. This will severely limit bond returns despite the rather higher yields now on offer. Just as importantly, as seen this year with bonds posting losses at the same time as equities, bonds no longer offer half the diversification benefits they have done in the past, Thompson concluded.

Kingswood Holdings Limited is an AIM-listed international fully-integrated wealth management group with circa £9.1 billion ($11.24 billion) of assets under advice and management.