Quilter Cheviot|Weekly Comment

Actions speak louder than words

Market Overview by Alan McIntosh, Chief Investment Strategist at Quilter Cheviot

For investors, last week was a mix of fortunes depending on whether you own bonds or equities. Equity markets continued to recover, building on the strong gains seen in the previous week. Measures of volatility were also subdued, suggesting that there was a greater feeling of calm. By contrast, bond yields, particularly in the US, continued to track higher. This reflected a more hawkish tone from the US central bank, the Federal Reserve, with several members of the Committee suggesting that the next move upwards in interest rates should be half a percent rather than the quarter point increase introduced at the last meeting. The uncertainty of war is no longer keeping bond yields down. The US central bank has decided that tackling inflation is the most important item on the agenda and that it will take advantage of a strong economy to introduce measures to reduce price pressures.

There is much comment around whether an aggressive interest rate policy could tip economies into recession and what effect that may give on markets. One of the indicators of possible forthcoming recession is when short-term interest rates rise above longer-term rates – known as yield curve inversion. Typically, observers look at the difference between two year Treasury rates and 10 year Treasury rates. Although this part of the yield curve is not yet inverted, the gap is narrowing. History shows it is a reasonable, although not perfect indicator. However, even after inversion, it can be several years before a recession occurs. Meanwhile, stock markets tend to rise in the year after yield curve inversion (in the absence of recession company profits continue to grow.) Nevertheless, recessionary conditions are usually negative for companies because profits then come under pressure. However, again, evidence shows that after an initial fall in share prices, markets tend to recover as the end of the economic downturn is anticipated. At present no recession is anticipated. But even if there were to be one in the next couple of years, the lesson of history is that it is better to stay invested if your time horizon is sufficiently long.

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