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DF September 2023 Newsletter

Today, on August 30th, 2023, we witness a celestial rarity: a Blue Moon. While many know the term "once in a blue moon" to express a rare event, not everyone realizes its astronomical significance. A Blue Moon refers to the second full moon in a calendar month, gracing our skies approximately once every 2.7 years.

Just as a Blue Moon is unusual, we find ourselves in an unexpected position in the real estate market, often considered a once-in-a-blue-moon situation.

Historically, real estate was viewed as a primary asset class in the 1960s. In those days, the average price of a home was less than $10,000, a sum comparable to today's car prices. The escalating real estate prices from the 1980s to the present day weren't purely a result of the appeal of bricks and mortar but were primarily driven by plummeting interest rates. As these rates reduced, the allure of owning property grew.

However, as the tides of time change, so do financial climates. With mortgages now rising above 6% in many parts of the developed world, we are seeing unprecedented challenges in the realm of real estate. This has tested its mettle as an asset class, prompting much reflection and analysis.

Given the current trajectory and market dynamics, we have taken a cautious stance, i.e. we are choosing to watch from the side-lines, hoping that our apprehensions prove misguided for the sake of the broader economy and that we regret missing any potential growth. In other words, we’d rather miss the boat than be caught in the middle of a storm.

The Blue Moon Phenomenon: China's Unexpected Stagnation

China, renowned for its millennia of rich cultural history and traditions, has always been deeply entwined with the movements of the cosmos. Celestial events are not just observed; they are revered, often signifying divine interventions or predictions for the days to come. While the term "Blue Moon" might be foreign to the Chinese lexicon, the current economic trends seen in China mirror this rare turn of events.

For decades, China's astonishing economic growth has been a given. It's the dragon that has soared higher each year, astonishing the world with its relentless pace of development. Yet, the present lack of growth is a 'blue moon' event in China's recent economic history.

Several factors have contributed to this anomaly. A prominent one is China's recent tensions with Japan, which have created economic and political ripples. But, perhaps even more significantly, China's real estate problem has begun casting shadows beyond its borders. These tremors were most pronounced when Evergrande, a real estate behemoth, declared Chapter 15 bankruptcy in the USA. This move essentially shielded its international assets from the clutches of US debt holders, signifying a vulnerability many had not anticipated from such a giant.

Moreover, the wounds of the global pandemic and the stalling pace of recovery post-COVID have only exacerbated these concerns. These uncertainties have made us wary of China's broader market landscape.

However, every cloud has a silver lining. China's technology sector, brimming with innovation and ambition, seems to be that shining beacon amidst these cloudy times. Interestingly, while many view the potential governmental division of major tech companies with apprehension, we see opportunity. This restructuring could decentralize power, minimizing monopolistic control by large entities and fostering an environment where growth and innovation can thrive.

Just as the blue moon shines brightly amidst the regular phases of the moon, we are optimistic that China's technological prowess will shine, offering avenues of growth even in these challenging times.

Navigating Interest Rate Dynamics: A Tale of Two Nations

In the complex landscape of global financial markets, interest rates serve as one of the most potent tools for central banks to influence economic growth, inflation, and currency values. The strategic management of these rates can catalyse prosperity, while missteps can precipitate economic stagnation or even crises. Recently, the divergent paths of interest rate policies in the UK and China offer a fascinating study in contrast.

United Kingdom: The Interest Rate Challenge

Post-Brexit and amidst the ongoing repercussions of the pandemic, the UK has faced an uphill battle in stabilizing its economy. Historically, double-digit interest rates in the UK have been tools to combat high inflation and stabilize the pound. Still, the ramifications of these high rates are evident in the current housing market. Rent and mortgage costs have surged at unprecedented levels, pushing the dream of homeownership further out of reach for many.

While the Bank of England, with the newly appointed consultant Ben S. Bernanke, harbours ambitions of trimming the inflation rates down to 2%, the pathway there is fraught with challenges. The twin pressures of ensuring economic growth while managing inflation expectations demand a delicate balancing act. Reducing rates too swiftly might overstimulate the economy, risking runaway inflation. Conversely, maintaining high rates can stymie growth and burden borrowers.

China: The Deflationary Spectre

Conversely, China's economic conundrum centres on an entirely different concern: the looming shadow of deflation. Traditionally an economic powerhouse, China's recent slowdown in consumer spending has raised eyebrows. A populace hesitant to part with their yuan means less consumption, which, in turn, can lead to falling prices or deflation. This spiral can deter businesses from investing due to anticipated lower returns in the future, leading to reduced economic activity and potential job losses.

To counteract this, Beijing may opt to reduce interest rates to make borrowing cheaper, aiming to stimulate spending and investment. However, this isn't a guaranteed remedy. The psychological factors driving consumer restraint, including concerns over the property market and broader economic uncertainties, may not be quickly allayed by rate adjustments alone.

An Overview of the Current Fixed Income Landscape

The intricacies of the global fixed-income market often function as a barometer for the broader economic climate, reflecting nuances that might not be immediately discernible in more volatile asset classes such as equities. The current state of these markets presents a mix of challenges and opportunities.

Inversion and Its Implications

Traditionally, a yield curve inverts when short-term bonds yield more than their long-term counterparts. This inversion can be seen as a warning sign, indicating a potential economic slowdown or even recession. However, from an investor's vantage point, this scenario can also present opportunities, especially in an environment where higher rates are prevalent.

For investors, the silver lining in this situation is the newfound ability to purchase bonds in domestic currencies at more attractive yields than before. As central banks in various regions navigate the complexities of their respective economies, the subsequent adjustments in interest rate policies create pockets of value in the fixed-income world.

Strategic Positioning

With the current landscape in view, certain maturity periods are emerging as sweet spots for bond investors:

US & UK Bonds: A 6-month maturity seems optimal. Given the economic uncertainties and central bank policies in both these regions, this duration strikes a balance between capturing higher yields and managing the risk of potential rate changes.

European Bonds: A shorter 3-month maturity is favourable. Europe's unique economic challenges and the monetary policies of the European Central Bank (ECB) make this duration an attractive proposition for investors seeking yield while minimizing exposure to interest rate volatility.

In the current climate, it's prudent for us to keep our bond duration relatively low, reflecting a cautious approach to manage interest rate risk. However, the market is ever-evolving. As the yield curve potentially begins to normalize and move away from its inverted state, opportunities to extend bond maturities and lock in longer-term rates will emerge. This will provide the opportunity for stable, attractive yields while also hedging against future uncertainties.

We will be discussing this and more in our upcoming Q3 economic update on 4th of October 2023. You can sign up to the webinar here.

On a lighter note, as the summer days shorten and we transition into the autumn months, we hope that you've enjoyed a season of joy, relaxation, and warmth. Though financial markets have remained relatively uneventful this summer, history tells us that September can be a turbulent month. But regardless of what the markets have in store, we remain committed to guiding and advising you with the utmost dedication.

Wishing you clear skies and smooth journeys, both in life and investments.

Best regards,

Brian Dunhill


Copyright © 2023 Dunhill Financial. All rights reserved.

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