Monday Espresso Podcast 13th June 2022

[00:00:00] Sheldon MacDonald: It is the 13th of June today. Last week we signalled that the main event to watch, this past week, would be the ECBs meeting. The ECB didn't hike rates as expected, but they did strike somewhat of a hawkish tone indicating that 25 and 50 basis point hikes are definitely in the offing. What did you make of that, Nathan?

[00:00:20] Nathan Sweeney: Yeah, so they didn't raise rates at this meeting, but they definitely used this as an opportunity to flag to the market, what next. The market had been expecting a 25 basis points rise at the July meeting, it now looks like that could be 50 basis points.

[00:00:35] Nathan Sweeney: So, this is changing that dynamic between interest rates and tackling inflation.

[00:00:40] Sheldon MacDonald: And certainly inflation on the radar at the moment, we saw a very high inflation reading out of the US.

[00:00:45] Nathan Sweeney: Yeah, so we had the inflation figures out on Friday and that number came in above expectations. So the expectation was we'd get a reading of 8.2%, it actually came in at 8.6%, so this is the highest inflation reading that we've had this year.

[00:01:01] Nathan Sweeney: So, this is counter to the point that we were at peak inflation. It looks like we are not at peak inflation.

[00:01:07] Nathan Sweeney: The key drivers behind that continue to be energy and food.

[00:01:11] Nathan Sweeney: But the other concern is housing because we're starting to see big moves up in rents and lots of housing demand still coming through.

[00:01:19] Sheldon MacDonald: So those higher inflation numbers certainly bad for Bonds, and we saw negative readings on the Bond front.

[00:01:25] Sheldon MacDonald: Also bad for equities, the higher inflation number, definitely turning the tone and we saw markets moved down quite strongly on Friday. The NASDAQ now in bear market territory, that means down over 20% for the year to date.

[00:01:40] Sheldon MacDonald: The UK though, providing a little bit of a safe haven. So the UK certainly was down last week, but less so and a couple of reasons for that.

[00:01:49] Sheldon MacDonald: So, part of that is Sterling weakness. Now the weakness of Sterling helped out UK investors returns on offshore assets as the Sterling weakens, as you translate those returns and foreign assets back to Sterling, it gives you a better number.

[00:02:04] Sheldon MacDonald: But that also helps the companies in the FTSE 100 who make their revenues offshore translating those offshore revenues back to Sterling gives you a stronger number.

[00:02:13] Sheldon MacDonald: The UK also very well-placed in terms of its structural makeup, so the UK well-placed to benefit from what's going on at the moment.

[00:02:21] Sheldon MacDonald: We've spoken about this before the higher weightings in banks and in energy companies, also helping. And finally, also UK evaluations still pretty attractive.

[00:02:30] Sheldon MacDonald: Even after adjusting for those sector differences, the UK market's still at a cheap valuation, still at a discount relative to other markets. We of course remain overweight in most of our portfolios in UK equities.

[00:02:42] Sheldon MacDonald: The final reason for being positive on UK equities is the good income that you get, and in a growth challenged environment, that we're seeing at the moment, companies that can deliver you a nice stable, steady income stream to pay dividends will get support we think.

[00:02:57] Sheldon MacDonald: Looking at the week ahead though, it looks like it's all going to be about inflation and about what central banks are going to do.

[00:03:04] Nathan Sweeney: Yeah, so if we look at the week ahead, we have the Fed have their meeting this week, so it's a two-day meeting. They will then release the results of that meeting on Wednesday, where they're largely expected to raise interest rates by half a percent or 50 basis points.

[00:03:18] Nathan Sweeney: So, the key question going forward, is what are they going to do with interest rates from here on out?

[00:03:25] Nathan Sweeney: The expectation is that we get a 50 basis point interest rate rise at the meeting this week. We get another 50 basis points interest rate rise at the meeting in July.

[00:03:35] Nathan Sweeney: But the question is, do they follow that up with a similar move in September?

[00:03:39] Nathan Sweeney: We'll find a bit more detail about that when they released their projections around interest rate levels, so the market would be very much focused on that. On top of that, we also have an interest rate meeting in the UK, so the Bank of England is meeting they're largely expected to raise interest rates by 25 basis points or a quarter of a percent, which would bring interest rates in the UK to 1.25%.

[00:04:03] Nathan Sweeney: All of these interest rate rises should cool inflation. So it should cool demand for mortgages, cool demand on housing and therefore you should start to see inflation coming down from here.

[00:04:15] Nathan Sweeney: So, our base case is that inflation should start to come lower as we move towards the end of the year.

[00:04:21] Sheldon MacDonald: A difficult period at the moment then. So after the last Fed meeting, we'd started to get a sense, perhaps that there might be the possibility that the Fed's moves would be lesser than had been expected, but at the moment, certainly pointing in the other direction. But as we've seen, things are changing all the time. Watch the space. We look forward to speaking to you again next week.

[00:04:43] Sheldon MacDonald: Thank you.

[00:04:43] Nathan Sweeney: Thank you. Take care.