The third quarter of the year has started off in the same vein as the first half of 2022, however the focus on markets looks to be subtly changing from an emphasis on inflation to the future consequences that tightening monetary policy may create.

In past interest rate hiking cycles, central banks have not been able to engineer the infamous ‘soft landing’ of bringing inflation under control without triggering a recession. The US Federal Reserve has enacted their second 75 basis point interest rate hike in a row, and the ECB enacted their first interest rate hike for several years at the level of 50 basis points. Investors are now turning their attention to whether central banks will be able to achieve a soft landing this time around.

The increased political risks emerging out of the UK and Italy, alongside the on-going issues of energy prices from the Ukraine war continue to elevate risks and volatility. The flow of natural gas in Europe has reduced (even though some supply has recommenced from Russia), increasing the risks that energy cuts may occur in Europe if demand outstrips the lower level of supply during the colder winter months. This will put added pressure on economic growth and make the ECB’s job even more difficult as gas prices are a large part of the high inflation numbers that are already present in Europe.

There is a lot of anticipated doom and gloom in markets that has been priced in, however not all of the current data is highlighting that the economic conditions are as bad as first feared. Consumer sentiment may be low; however, spending continues to be strong, saving levels are being reduced, travel numbers are positive, and the jobs data is extremely strong. Jobs and spending numbers are not normally this strong at this point in the cycle. This is something investors will continue to monitor as these data points are contrasting against the imminent recession fears dominating market rhetoric. 

Q3 earnings season

During the month, the 3rd quarter earnings reporting season got underway. For many companies the data released was relatively strong even with the negative market backdrop of higher inflation, rising interest rates and recessionary fears. Many of the companies that have beaten expectations have highlighted changing economic conditions that are providing some headwinds, but not enough to slow growth and decrease earnings substantially. This is providing dislocations between current market valuations and company fundamentals which our active managers are trying exploit. The recent meetings we have had with the managers within in our portfolios are saying that the current pricing points are low and there are many positive stock ideas where the opportunity for outperformance is significant. What is being valued into share prices is not what companies are experiencing. Focusing on company fundamentals first and foremost will be key to manoeuvre within the current economic backdrop.