WeekWatch

US stocks rose last week, as positive economic news in the US combined with falling inflation figures to spur hopes that the US might be able to return inflation to normal while growing the economy.

Inflation fell to just 3% in June. This compared to 3.8% in May. It is now just 1% above the Federal Reserve’s 2% target.

‘Core’ inflation, which doesn’t include food and energy prices, fell by more than expected to 4.1%. By removing more volatile sectors, core inflation can help offer a more stable picture of real inflation (for example, it won’t be so affected by a spike in the price of oil).

After pausing interest rate rises in June, the Fed met last week and agreed to raise interest rates again. The 0.25% rate increase agreed upon left interest at the highest level in 22 years.

Markets were already widely expecting this move after a pause in June, so the tone of the messaging that went along with the rate change was of greater interest. Speeches and communications from key decision makers can be used by investors to try and gauge the feelings within the Fed, in an attempt to better anticipate future moves.

In this case, Fed chairman Jerome Powell said: “It is certainly possible that we would raise the funds rate again at the September meeting if the data warranted. And I would also say it’s possible that we would choose to hold steady.”

Mark Dowding, Chief Investment Officer of BlueBay Asset Management, said this meeting “passed without much comment.” He noted: “Money markets are evenly split in terms of whether this week’s hike will be the last of the cycle, or whether there will be one further move to come in September or in Q4.”

With rates already at a 22-year high of 5.5%, on balance Dowding speculates that the Fed is likely nearly done with rate rises for now.

As inflation returns to normal, questions are likely to be asked when interest rates might be brought back down.

While inflation is an important element to consider, it isn’t the only element the Fed will be looking at. It will also look at general economic performance in the US. And in this case, Powell and his colleagues might well be pleased.

Often economists look at these inflation periods through the lens of the Goldilocks fable. If interest rates are pushed too high, it could push the economy into a recession. If the Fed doesn’t act decisively enough, it could result in runaway inflation. But if they get it ‘just right’, a ‘soft landing’ can occur, where inflation is brought under control without causing a recession.

New GDP figures from last week fed into this Goldilocks narrative. The US announced its economy grew by 2.4% in the second quarter, year-on-year. This was above the 2% recorded in the first quarter, and well above market expectations.

With inflation falling and the economy apparently doing well, it was unsurprising that markets had a positive week in the US. The S&P 500, for example, rose 1.01% over the week. Once again, the large tech mega caps drove much of this performance.

European markets were more muted. While inflation on this side of the Atlantic has also been falling, it’s been at a slower rate and has been accompanied by a slowdown in economic performance.

In the UK, where inflation remains higher than in the US, the weekly return was just 0.4%, as mixed company earnings saw FTSE 100 company performances vary.

France saw a similar performance, with the CAC 40 returning 0.59%. Meanwhile, the German DAX Index grew 1.81%.

Although the European Central Bank increased interest rates last week, there is an increasing sense that the end is in sight for these rate increases, as inflation across the continent continues to fall.

Wealth Check

Whether you’re looking to exit your business altogether or just release some value, private equity (PE) firms might be an interesting potential buyer. There are advantages and disadvantages to selling to PE investors, so it’s important to take all considerations into account.

Advantages:

  • As an SME owner, you’ll have built up value in your business throughout its life. That value may even represent a large part of your wealth. Selling part of your stake in the business to a PE investor can allow you to realise that value and free up capital to fulfil financial goals in your personal life while retaining a stake and role in the company.
  • In addition to facilitating your exit, a private equity investment can provide a capital injection for the business. That means you could finance growth projects such as expanding operations or investing in modern technologies.
  • PE providers usually have industry-specific knowledge and experience and could advise you on anything from strategic planning to operational efficiency and market expansion. This can be particularly beneficial for SME owners who lack specific resources or expertise.
  • PE houses typically have extensive networks and resources, so they may be able to connect you with potential customers, suppliers, or advisers to support your growth. If you want to expand into a certain sector or region, seek a PE partner specialising in that area.

Disadvantages:

  • Any buyer will scrutinise your company in detail, but PE firms can be particularly intense. A spokesperson for the British Private Equity and Venture Capital Association (BVCA) says PE firms will expect detailed documentation, such as financial statements, projections, cash flow analysis and valuation reports. That’s in addition to company records, contracts, and other legal documents.
  • Whereas you used to decide what happens to your firm, you’ll be in the hands of new owners post-sale, and they may have different ideas or processes.
  • PE firms are often hard-nosed negotiators. Good advisers are essential to help you understand and consider the conditions carefully. Be ready to stand your ground.
  • Because PE firms typically acquire a significant stake in the business, they will have significant influence. The new ownership may bring changes in the company’s culture, management, and operational practices – which could impact employees and stakeholders.

Business exit strategies may include the referral to a service that is separate and distinct to those offered by St. James’s Place.

In The Picture

Inflation and interest rates have been key drivers of market performance over the past 18 months. With inflation now falling among Western economies, questions are now being asked about what will happen with interest rates. The chart below shows the market’s expectations for policy rates in different economies over the next five years.

Source: Bloomberg, J.P. Morgan Asset Management. Guide to the Markets – UK. Data as of 21 June 2023.

The Last Word

“When we reach net zero in 2050, a quarter of our energy needs will still come from oil and gas, and domestic gas production has about a quarter or a third of the carbon footprint of imported gas.”

Rishi Sunak defends his decision to grant new licences to explore for oil and gas in the North Sea.

Bluebay is a fund manager for St. James’s Place.

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