Market review: January to March 2023
Global stocks were resilient during the first three months of 2023. After a strong start to the year, confidence faltered somewhat as investors digested the impact of a difficult macroeconomic backdrop, the ongoing conundrum of the direction of interest rates, stubbornly high inflation and a banking crisis.
There was a sharp sell-off over the quarter after the collapse of Silicon Valley Bank (SVB) in the US. The bank was caught out after investing client deposits in assets that fell in value due to rising interest rates. When clients came to take their money out, the bank found it did not have enough invested to meet the withdrawals. The bank collapsed, although savers – mostly technology start-ups and venture capital investors – were bailed out by the Fed.
The collapse of SVB put other banks in the spotlight. This sparked a banking crisis as depositors acted to get their money out of banks that looked stretched. The effects spread to Europe as Credit Suisse was taken over by UBS group in a deal sponsored by the Swiss government. Swift action from regulators, politicians, and central bankers eased markets fears] that a revival of the 2008 crisis had started and markets rallied towards the quarter end.
The crisis left central bankers pondering their next move. The Fed had to balance the need to tame inflation with a desire to avoid any further financial instability; policymakers in the UK and Europe, meanwhile, remained committed to rate rises while GDP growth was positive.
Global government bonds continued their longest stretch of sustained volatility since the onset of the global financial crisis. The conflicting pressures on central banks meant that the direction of rates was hard to predict, leading to big moves in yields, both up and down (signalling changes in the price of the underlying bonds) as investors factored in the conflicting news flow.
The oil market had a tumultuous quarter. The price rallied at the start of the year as the Chinese economy reopened and further sanctions were placed on Russian imports. There was then a major sell-off in March in the wake of the banking crisis, with the price per barrel crashing to multi-year lows, but prices were then boosted by the easing of banking fears and production cuts in Kurdistan.
Market review: April to June 2023
Global stocks were resilient in the three months to the end of June, with shares generally providing a positive return. June brought the most positive news for markets, as the US Federal Reserve (Fed) paused its rate hiking cycle as inflation retreated, although central bank chair Jerome Powell said that two further rate hikes this year are still on the table. Additionally, first quarter GDP growth in the US was revised up to 2% from the initial forecast of 1.3%, providing further confidence for markets.
This followed a more difficult start of the quarter where the shockwaves of the regional banks crisis in March still reverberated and a political stalemate over spending – the ‘debt ceiling crisis’ – threatened to throw the US economy into turmoil. A bill to resolve the debt issue was finally passed in early June, contributing to the market recovery later in the month.
The US is the world’s largest economy and its fortunes can have a big impact on investors. As a result, share prices soared, with the hard-pressed technology sector in particular benefiting from the hype around artificial intelligence (AI) in the wake of the launch of ChatGPT. Meanwhile, the eurozone’s slip into a mild recession and concerns about the ongoing economic slowdown in China failed to blow stocks off course.
European stocks ended the quarter marginally positive, despite the eurozone falling into a mild recession, with GDP growth of just 0.1% in the first three months of the year. China is a major trading partner for Europe, and so markets were buoyed by a pledge from Chinese president Li Qiang to further stimulate economic demand. Continued falls in inflation across the 20 countries that use the euro currency were also a positive influence on share prices. However, the European Central Bank raised interest rates by a quarter of a percentage point to 3.5% and signalled another hike to come next month, suggesting that inflation has not yet been tamed.
UK share prices also edged higher, helped by a lastminute rally by the FTSE 100 Index on the final day of trading in June. The UK suffered from a lack of heavyweight technology firms which were bolstered over the month by the hype surrounding artificial intelligence (AI), and a slide in the oil price, as a number of large energy companies are listed on the London stock exchange.
Global bond yields rose (meaning bond prices fell) over the quarter as central banks continued their aggressive interest rates hiking cycle and economies fared reasonably well.
Market review: July to September 2023
Investors remained focused on economic data over the three months from 1 July to 30 September 2023. Inflation has been falling and this has led many analysts to conclude that central banks – such as the US Federal Reserve, the Bank of England and the European Central Bank – won’t need to raise interest rates any further to control it. This is good news for share markets because high interest rates make it more difficult for companies to borrow money to expand their business and increase profits.
Since the start of the year, equity markets have been rising on the basis that a change in direction on interest rates was imminent. However, markets stalled in the third quarter, as economic data suggested that rate cuts might be coming later rather than sooner.
An important factor that investors are watching is economic growth. This is generally measured by changes in the gross domestic product (GDP), which totals up the value of all the goods and services that a country produces. When GDP is going up, economic activity is increasing, which is a good thing, but it also means there is greater demand for goods and services, which puts upward pressure on prices. If it starts to fall then economic activity is shrinking, and while this can help reduce inflation by reducing demand it can also lead to job losses, business closures and lower investment. When GDP falls for two or more quarters in a row, an economy is said to be in a recession.
Central banks are trying to thread the needle of reducing economic activity enough to help reduce inflation while not going so far that it causes real damage to the economy. This is proving quite difficult.
At the start of the summer there was a debate about whether the US could avoid a recession and how quickly the US Federal Reserve was going to cut rates to reduce the chances of this happening. However, in Q3 the US had a remarkably strong economy, with GDP growing by 4.9%. In the meantime, annual Consumer Prices Index (CPI) inflation was on the rise: in June it was 3%, then 3.2% in July before ending the quarter on 3.7%. This is much lower than the 6.4% it was in January but still quite far away from the US Federal Reserve’s 2% inflation target.
The USA is the world’s biggest economy and what happens there has a major impact around the globe: an old investor saying is ‘when America sneezes the rest of the world catches a cold’, and so investors pay particular attention to the USA. But the situation is similar in the Eurozone and the UK, although economic growth hasn’t been as strong in the third quarter.
It is generally accepted that interest rates are at their peak and cuts will happen at some point, but no one knows for sure when that will be. The major central banks all held rates steady at the end of the quarter and some economists are talking about a ‘Table Mountain’ effect where there are no more rises but rates remain high while inflation slowly declines. This uncertainty has led to unstable bond markets, where the direction of interest rates is a vital concern to performance, a situation that could continue until there is a clear indication that interest rates are falling.
We think that we will see weaker economic data in the coming months, and this will stop central banks raising rates any further. In the US, inflation fell back to 3.2% in October, suggesting that inflation was still going in the right direction. Even so, we think it is unlikely that the US Federal Reserve move to cut rates before the second half of 2024. In the UK and Europe, where economic growth is weaker, cuts could come earlier, although still not before the middle of next year, in our view.
This is a positive environment for bonds, especially longer dated bonds – those with 10 years or more until maturity – because falling central bank rates will make their repayments more attractive in the long term. There are also opportunities right now to lock in higher yields: bond prices have fallen while rates have been rising, and so the amount they pay out relative to their price has become more attractive. When interest rates fall and bond prices improve these levels of yield won’t be on offer.
Equities are still positive for the year so far, but performance levelled off over Q3. We are seeing a kind of two-tier market, as companies in the technology sector have continued to increase in value thanks to holding large amounts of cash that has protected them from the impact of rising interest rates. They also have products that consumers want, so plenty of demand, and excitement around AI has also driven investors into the sector. We think these trends are likely to continue. Outside of tech, many companies could struggle to increase their profits as the economic situation weakens over the next six months or so, and this is likely to be a drag on overall market performance.
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