US interest rate surprise and market reactions

After a somewhat subdued start to the month, a series of positive developments (for investors, at least) culminated in a larger-than-anticipated US interest rate cut. At the onset of the month, certain indicators of US inflation were showing sluggish progress, and jobs data didn’t signal a recession. This combination led market players to moderate their expectations, not anticipating more than a 25bp cut. However, the Federal Reserve (Fed) surprised most commentators by cutting 50bps. By the end of the month, the Fed’s preferred inflation gauge had nearly reached the 2% target. This has raised hopes of another 50bp interest rate cut at the next meeting. What's particularly interesting is that this meeting falls the day after the US presidential election, potentially adding a new dimension to the market dynamics. 

The Fed's dual responsibility  

Unlike many other Central Banks, the Fed has a dual responsibility. It is not only tasked with managing monetary policy to ensure stable prices but also aims to achieve full employment. In practice, this doesn’t mean everyone has a job; there is an economic cycle, industries’ fortunes fluctuate, businesses close, and people are temporarily out of work as they change jobs. A ‘natural’ unemployment rate in most economies, depending on government policy, prevails when an economy is stable – this is around 4% of the working population. The long-term average in the US is 5.7%, but the current rate is 4.2%. In contrast to the inflation position, as I remarked above, there doesn’t seem to be much evidence that the jobs market required the stimulus of a bumper interest rate cut. The Fed might be excused, therefore, if it limits its next interest rate move to a 25bp decrease. 

Stock market seasonality: Sell in May, come back on St Leger Day  

According to legend, on our side of the pond, September is when stock markets emerge from the summer doldrums and, reinvigorated, resume their longer-term ascent. “Sell in May, go away, come back on St Leger day” is probably derived from the 19th-century aristocracy's propensity to migrate from town to a country estate seasonally. London stank in the summer as untreated effluent washed up on the banks of the Thames; hence the City was depleted of its movers and shakers, and market activity was thus moribund. 

The UK stock market: Resilience despite headwinds  

It is debatable whether that tactic gains any systematic advantage, but certainly, the UK market’s headline index has travelled a sideways path since May, at best showing resilience in the face of external factors.  

Despite a 0.25% rate cut and superior growth forecasts from the Organisation for Economic Co-operation and Development (OECD), the level of the FTSE All-Share index has made little progress. However, as we stress regularly in these commentaries, the UK index by weight is dominated by the FTSE 100, whose price is overly controlled by very few companies. For example, Shell and BP make up ~10% of the index, and their values have been depressed by the impact of a falling oil price. That weakness results from low demand (China) and a glut of stored oil in refineries. Thanks to shale oil, production in the US has accelerated to the point where it now the world’s biggest oil producer (13 million barrels a day). 

Smaller companies' performance in the UK market  

In contrast, the smaller companies within the UK index gained almost 9%, and the FTSE 250 almost 7%. This reinforces our view that we should ensure our UK equity portfolios are regularly rebalanced across investment styles – company size, growth stocks and fundamentally undervalued areas of the market, i.e. so-called ‘value’ companies. 

China’s golden week and stock market rebound  

The start of October marks the commencement of the Golden Week holiday in China. Its stock market certainly had a glittering last week of September, its main stock market rising 25% in six days. This was a reaction to a host of rate cuts and other surprise measures announced by the Chinese Communist Party intended to “spur a stable recovery”. 

Lessons from gold sales and the importance of patience  

Those old enough to remember a certain Gordon Brown as Labour chancellor may recall that in 1999, after a lengthy bear market for Gold, he started a 3-year programme of selling the family jewellery, i.e. 400 tonnes of our long-term gold reserves, and at a fire-sale price. This raised less than £2.5bn (£4.7bn in today’s money, mainly used to buy US dollars and a new-fangled coinage known as the ‘Euro’. Today, many countries don’t want to be at the mercy of the dollar anymore, and they are selling foreign currency in exchange for the shiny yellow stuff. A Euro is worth (in £) 18% more than it was in 1999, and a dollar some 24% more. That’s an investment return of less than 1% pa, while inflation has reduced that by almost 50%. At the end of September, Gold passed the £2000 per ounce barrier. Had we held onto our investment, our £2.5bn would be worth over £21bn. 

A salutary lesson for long-term investors - sometimes, doing nothing is the wisest strategy... 

Graham Bentley

Chief Investment Officer

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