Jeremy Hunt knew that he did not have a huge amount of room for manoeuvre when he delivered his autumn statement last week. Indeed, at its core is a package of eye-watering spending cuts and painful tax rises. Benefits and pensions, however, are being increased in line with inflation – which will bring relief to the less well-off.
Although the primary impact will be felt by UK taxpayers and savers, the Chancellor’s message was aimed at international investors. In many ways, it was designed to restore the UK's reputation for financial prudence – a reputation which has taken something of a hit in the wake of the previous Chancellor's disastrous budget.
The pandemic, Russia’s invasion of Ukraine, a decade of sluggish growth and the rising cost of interest payments on government debt have all left their mark. And the situation worsened in October when the Bank of England was forced to intervene in the bond market and address a “material risk” to UK financial stability.
According to the OBR (Office for Budget Responsibility), the UK is already in a recession. The Bank of England, meanwhile, has warned that the UK is facing its longest period of negative growth since records began: a "very challenging" two-year slump lies ahead, and unemployment is predicted to almost double by 2025.
Given the gloomy outlook, it is hardly surprising that traders and investors have been so pessimistic – particularly given that inflation hit a 41-year high of 11.1% in October. Both the government and the Bank of England are determined to tame inflation. But UK households need to prepare themselves for more hardship before we see any signs of a recovery.
In his speech, the Chancellor's referred at length to the war in Ukraine, the downgraded growth forecast, and the massive rise in energy prices (which have driven up food prices). The higher levels of debt (one of the scars left by Covid) and rising interest rates are other challenges – resulting in the government’s decision to hike taxes to their highest level since just after the Second World War.
This decidedly un-Conservative U-turn on taxes has raised eyebrows. As things stand, the key issues over which the next election will be fought are not yet known. They could include tax rates, but it could just as easily be fought over the state of our crumbling public services and which party might be best placed to generate the growth needed to mend them. After more than a decade of the UK overdosing on austerity, Brexit, sluggish living standards and political turmoil, there is every possibility that the electorate will decide that a change of government is what we need.
Global investors seem to be significantly more upbeat about the situation in the US. Following the mid-term elections of a fortnight ago, the Republicans are back in control of the House of Representatives. That said, their win was not quite so overwhelming as many had predicted. But the party finally won its crucial 218th seat in the lower chamber of Congress, paving the way for a showdown with Joe Biden in the second half of his presidency.
Meanwhile, Donald Trump has announced his candidacy. Although the former president’s popularity has taken a hit in recent days, his potential to become the Republican nominee (and indeed win in 2024) should not be underestimated.
It is just possible that US inflation has peaked, in which case the Fed will be able to ease off on its aggressive interest rate policy. Federal Reserve Bank Vice Chair Lael Brainard indicated that it might be able to temper the size of its interest-rate increases very soon, in which case, next month’s interest rate hike might be closer to 50 basis points, rather than the expected 75 basis points.
The US economy is also off to a better-than-expected start for this quarter. In fact, some economists may even revise up their GDP forecasts for the final quarter of this year. Should this momentum continue, then the US recession that many are forecasting may not actually materialise. New data on retail sales is strong, while initial claims for unemployment insurance benefits remain low. The US housing market, however, continues to feel the pressure of rising mortgage rates.
China has just issued its 16-point plan to boost the real estate market – the strongest sign yet that President Xi Jinping is focusing his attention on bolstering the world's second-largest economy. This development was welcomed by the Chinese stock market.
It is impossible to pretend that 2022 has been anything other than extremely difficult for financial assets: war in Europe, higher inflation and rising interest rates have all created headwinds. But economists continue to believe that both will peak in 2023, before beginning to fall. Have markets bottomed out already? That’s difficult to say, but certain markets (including the UK) look cheap. Of course, there are still no guarantees that “cheap” means “good value” – given the economic and political backdrop.
There are also indications that we are heading for a housing market downturn or even a crash. Although the new government looks relatively stable, it is not popular. And its actions will come under growing scrutiny as the election approaches. Inevitably, government action will combine with the Bank of England's monetary policy to make things difficult for households.
That said, markets could start to rally higher as December swings into view. Interest rates are still running everything in the stock markets. So any upbeat news that emerges from the Fed’s meeting next month regarding the recent dip in US inflation could positively impact stocks and bonds. We, therefore, remain cautiously optimistic as far as current investment conditions are concerned.
We expect the equity markets to remain highly volatile and uncertain in 2023. But investing in high-quality stocks that are well-placed to weather further market volatility still makes sense. And capturing the higher levels of interest and dividend income that are now available is attractive as a total return strategy.
The recent sharp sell-off has created investment opportunities, and those who can withstand the roller-coaster ride are likely to be rewarded over the long term. “Never waste a good crisis”, as the old adage goes. Global economic certainty appears to be the norm, and geopolitical risks are likely to increase as the world becomes a more complex place. But those factors can combine to create great opportunities for those who do not need access to their capital over the very short term and are able to focus on longer time horizons.