More volatility than a chemistry experiment (WTF Economy #106)
UK cabinet shuffle and Truss’ about-face
We’re starting off this week by continuing the hit parade coming out of the United Kingdom. As we wrote last week (and two weeks before it), the British economy and underlying financial markets have been hit with unprecedented turbulence due to a flawed fiscal strategy laid out by the new government.
If you haven’t been keeping score at home, the story goes like this:
In early September, Liz Truss replaced Boris Johnson as the Prime Minister
Two days later, the Queen passed away
After a 10-day mourning period, she, along with her finance minister (the chancellor of the exchequer) Kwasi Kwarteng released a “mini-budget’” for the UK economy.
The plan centered around service reductions and tax cuts; the latter of which would disproportionately benefit the wealthiest of the UK society
This plan was supposed to stimulate the UK economy. However, with inflation high due to the pandemic, war, and Brexit, it directly contradicted efforts by the central bank (the Bank of England) to cool the economy down
Markets revolted, sending the pound plummeting and the cost of borrowing money for the British government soaring
UK pension plans were badly hit as they rely on government debt to help pay their policyholders
Markets and other analysts were in disbelief, and began comparing the British economy to that of emerging markets, and losing almost all trust in the government.
Well, the story continues. By the end of last week, Truss, facing enormous pressure, fired Chancellor Kwarteng and replaced him with technocrat Jeremy Hunt.
Chancellor Hunt immediately went to work righting the ship, and yesterday, he announced that almost all of Truss’ tax cuts would be reversed.
The markets rallied around this news, sending the pound stronger and dropping yields (i.e. the interest rate) on British government debt (called gilts).
However, the damage remains and questions about the current government’s future abound. For one, it’s widely believed that investors have zero confidence in Truss as PM. Likewise, polling shows that her Conservative party would likely get routed in an election.
While Hunt extinguished one fire, there are others still burning. With her being the 2nd Prime Minister in as many years of the most recent vote, there’s broad speculation that a general election could loom large. Investors are holding their breath for now, while they wait for certainty and stability with the UK government.
US stocks weirdly on the rebound
On the other side of the Atlantic, things are looking different. It’s no secret that this year has been a bad one for stocks. The US flagship index the S&P 500 has been leading the way, losing 30% of its value this year.
(Note: it’s still up 37% from the start of the pandemic and is 800% stronger than it was 30 years ago. Long term investing is how we get wealthy).
Regardless, it’s been a rough year for the index, as a few factors have given it a some serious headwinds, including:
A cool down from the pandemic economy where tech stocks did exceedingly well (since we were all working from home)
The war in Ukraine pushed gas and oil prices higher across the globe while stroking geopolitical tensions
Inflation picked up as a result of these forces along with continued supply chain issues
All of these factors lead to the US central bank -- the Federal Reserve -- raising interest rates to try to cool off a hot economy (the US unemployment rate is at its highest levels since the 1960s).
Markets and traders saw these moves as bad news for the short-term, leading to sharp sell-offs and a historically strong dollar.
This decline, in turn, led to fears that a recession in the US is on the horizon, creating a vicious cycle of stock selling.
Then, yesterday, the markets started to turn around. As company earnings came in, investors learned that the firms they’re investing in are still selling better than expected, driving up their share prices.
Second, the UK’s move to reverse the Truss mini-budget trickled over into the US, as the British economy is still an important one in the developed world.
Right now, markets are tracking up, with some hope that things are maybe better than the pessimists (aka the bears) believe.
The problem, though, is that 2022 is all about uncertainty. Even in the best of times, markets are nearly impossible to predict. These days, things change in an instant. Again, if you’re a long-term investor building your wealth, these moves shouldn’t phase you. Still filtering out the noise is never easy. Stay strong out there.