One month on and there is something of a sea change going on; inflation is proving to be stubborn and anything but ‘transitory’.

Central banks are having to eat their words and admit that tapering needs to commence and base rates need to go up. Beside the official inflation figures and jump in energy prices, at the coal face, Unilever has just reported an increase in their prices of 4.1% in the third quarter (passing on the jump in raw material costs) and expect to be doing the same in Q4. Bond markets took note (finally) and rates are rising: the UK 10-year is at 118bp from 73bp last time and more than double the summer lows. The US 10-year has followed a similar path up to 165bp from 128bp last month.

Of course, this takes its toll on Gilt prices, the 10-year is down 5% over the month and thirty-year by 9%. Not that the real yield on these assets makes them any more attractive than in the summer with inflation accelerating. So, as I think we have been saying for months now, tapering should start in November with rate increases to follow, quite possibly the Bank of England might be the first to move on rates. I don’t envy the central banks job in balancing an end to the ‘extraordinary’ stimulus with moving too fast and creating other problems, though it was a touch silly to hold the transitory line for so long. It is definitely time for rates to be ‘normalised’ (sorry).

The 0.4% UK economic growth for August reported by the ONS generated lots of angst. On ONS data UK activity was just 1.1% below pre-pandemic levels, but trying to read too much into monthly GDP data is folly, particularly so at the moment, these figures have always been subject to ‘revision’. On the numbers we follow, the economy is running at 102% of pre-COVID levels.

Equity markets are struggling with a push me/pull you here, falling quite sharply to the end of September then rallying all the way back and more as the reporting season gets off to a strong start. We suspect that this on/off mood is likely to persist.

It has not been a month of plain sailing for an absolute return fund that utilises the fixed interest markets for an important part of its return, but we do welcome the beginnings of a return to sanity. The asset mix of the Fund is shown below, we have actually edged-up our fixed interest exposure as one or two bargains are appearing, though we are maintaining the overall duration at just 2.4, see chart, right.

As has been the case for a while, we have been keen to maintain/build our book of holdings in AAA-rated floating rate notes (FRNs), adding to three existing holdings over the month from the Bank of Nova Scotia, Royal Bank of Canada and TSB Bank - here, of course, we look forward to base rate increases. Our principal purchase in fixed interest was a new issue from Rothesay Life of stock with a 5% yield, a while since we have seen that from a name that we like, but this is a hybrid so only one step up from equity. The move in rates has also flushed out a few zero dividend preference shares for us to pick up on yields over 3% for sub 3-year paper.

We have marginally reduced exposure to infrastructure assets but no major change to report. We added further to our latest convertible holding, Delivery Hero of 2.125% stock convertible until 2029, when markets dipped. We were encouraged by a positive statement from Shaftesbury as to activity in the West End, which also cheers Capital & Counties and their 2% convertible that we hold.

We have been active in equities. We have significantly reduced exposure to private equity, which has been on something of a tear, while adding to two favourite Swedish holding companies, Investor AB and VNV Global. Aviva also returns to the portfolio after a three year absence (the price is lower now but the company is much better placed).

The current round of supply shortages and raised energy prices will undoubtedly take the gloss off growth in the final quarter. These ‘big picture’ issues are being made worse for the UK with our own particular Brexit-related problems, not to mention bouts of panic buying. Despite all that is going on, the backdrop still looks healthy, household finances are strong, businesses are keen to invest and to hire more staff, and the progress on vaccines has been extraordinary. So our feeling is that this is a case of growth deferred, lower in the fourth quarter of this year but higher in the first half of 2022 as global supply improves and the bottlenecks ease.

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