Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

THE UK has been off investors’ radars so far in 2023. The tech-fuelled rally in the S&P 500 has largely passed us by and the FTSE 100 is barely higher than it started the year, at 7,643. This week, however, our home market is in focus with the spotlight on mortgages, inflation and interest rates.

More mortgage pain

The two big numbers this week will be Wednesday’s Consumer Price Index (CPI) announcement, followed a day later by the Bank of England’s latest decision on interest rates. Inflation is heading in the right direction but not quickly enough, according to Bank of England governor Andrew Bailey, who warned this week that his job is far from done.

May’s inflation rate is forecast to have come down modestly from 8.7% to 8.3%, still more than four times the Bank’s 2% target. The big driver continues to be wage growth, currently running above 7% and threatening a so-called wage-price spiral in which higher prices fuel higher pay demands which in turn force companies to push prices up and so on.

Persistently higher inflation means another interest rate hike is all but nailed on this week. Currently 4.5%, the UK base rate is expected to reach close to 6% before it finally peaks. That forecast trajectory is already feeding through into bond yields and mortgage rates, with the average cost of a 2-year fixed home loan rising above 6% today.

Meanwhile, over the pond

The UK’s gloomy economic outlook may be feeding through into stock market underperformance, but across the Atlantic it’s a very different story. Here the big question continues to be whether or not the 20%+ rise in share prices since last October’s low is the start of a new bull market or just another bear market rally.

Although the recovery since last autumn has been driven by a worryingly narrow group of mainly big tech companies, with the rest of the market lagging well behind, there is evidence that the bull market is beginning to ripple out. Typically, a bear market rally peters out after clawing back 50% or less of the previous bear market decline, so the current gain of more than 60% looks promising.

In valuation terms, too, a typical early cycle rally sees price to earnings multiples rise by 44% so the gain of 28% since last autumn (from 15 times earnings to 19) looks like it could have further to go. Were that average valuation to rise to 22, which is what a 44% gain would imply, then the S&P 500 could reach 5,300 on the basis of current earnings forecasts.

Where next for the 60/40?

One of the big debates of the past year or so has been whether bonds and shares will continue to help investors to a smoother investment journey thanks to the different ways in which they respond to the same economic events. Last year, unusually, both assets fell together and there was no diversification benefit.

Earlier this year, BlackRock warned investors that this might be a template for the future and encouraged them to diversify more widely. This week, however, Vanguard waded into the debate with evidence that last year’s disappointment was unique. Since 1977, it said, bonds and shares have never both fallen together except last year. In every other year, either both assets have risen or one has risen to offset a fall in the other. The death of the balanced portfolio may have been exaggerated.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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Ed Monk

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Ed Monk

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