As the first chart below shows, June saw another very strong month for US growth stocks, proxied by the NASDAQ (pink line), which rose by 6.7%, while broad US stocks in green were also strong, rising by 4.2%.
Asian and emerging market equities also did well (yellow and orange lines), though this month neither were driven by China, which fell by 2% (purple line). Rather, returns were boosted by the likes of India which rose by 6.7%, and where returns continue to be extremely strong despite high valuations and an unexpected election result; South Korea which rose by 7.9%; and particularly Taiwan which rose by 11.7%. Taiwan is home to TSMC, the world’s most advanced producer of semiconductors and a very large component of both the MSCI Asia Pacific (9.3%) and MSCI Emerging Market (9.7%) indices, which had a very strong month in rising by 17.7%.
All of the above outweighed specific Chinese weakness and helped both broad indices do well.
Elsewhere, there were some disappointing numbers for the FTSE 250 (light blue line) which fell by more than 3% after a cocktail of worse than expected macroeconomic data, and for Europe which fell by 1.7% on French election worries.
Finally, precious metals had a more muted month with silver (light green line) falling by 4.2%. We feel that this was just a pause for breath after a very strong run up, and indeed so far in July Silver is up by nearly 4% in GBP terms:
Taking a look under the bonnet of global equity returns, we find that once again smaller companies underperformed their larger counterparts substantially over the month, by around 4%. Despite over the longer term smaller companies tending to outperform larger, this underperformance phenomenon has now been playing out for more than 5 years as a result of investors’ increased focus on large technology stocks, and more recently, a higher interest rate environment which tends to be worse for smaller companies.
Smaller companies now look very cheap indeed relative to large companies, and as the chart below shows, have just suffered their worst half-year performance on a relative basis in their history, with data going back to the 1970s. This is one of the many dislocations in markets today caused by excessive optimism in parts of the equity market, and one we think will close over time.
In fixed income, as the next chart below shows, June was a positive month in the round for most areas, despite some weakness into the end of the month. Only global inflation linked bonds (light blue line) were negative, falling by 0.25%.
Again we saw some large fluctuations, but this month in general government bonds outperformed corporate bonds. We saw a sharp dip at the start of the month in line with a very strong US jobs report, but those losses were then erased by gains resulting from a slightly softer than expected US inflation print which sent yields lower and prices higher. Despite a roll down into the end of the month, most indices ended high, with UK Gilts (dark blue line) the strongest performers, rising by 1.3%.
June and very early July saw a large number of elections taking place, including of course in the UK, where, as was widely predicted, the Labour Party won itself a very large majority, while the Conservatives collapsed to their worst result in history; winning 121 seats and just 23% of the vote share, and the SNP in Scotland similarly so; losing 37 seats largely to Labour.
What became very clear quite quickly was that the seat gains for Labour and the Liberal Democrats were not generated by an upswell in popular support – their vote share barely budged from 2019 – but instead were largely powered by a big turnout from Reform party voters who ate into conservative party support, allowing the other parties to swoop in.
The chart below shows every seat that was lost by the conservatives represented by arrows, with each portion of the arrow coloured and sized by each relevant party’s vote share increase, and the winning party on top. As can be seen quite clearly, most of these arrows have a large chunk of light blue in them, signifying Reform voters played a major role in the flipping of seats:
So despite the headline result, it wasn’t all plain sailing, with Labour perhaps not as popular as it might seem. We saw one of the lowest voter turnouts for 100 years, and as the chart below shows, with data going back to the 1940s, we saw by far the largest gap in recent history between vote share and seat share – Labour won 63% of seats with 34% of the vote, and further down the leaderboard, while the Reform party won 600,000 more votes than the Liberal Democrats, they won just 4 seats versus 71.
So while Labour have won the right to govern the country, they are not necessarily backed by a very high proportion of the country’s voters, meaning they have plenty of work to do to win over additional voters during the course of their term of office.
In terms of a market reaction, given the outcome was entirely in line with expectations, the price action across equities, bonds and the pound has been minimal, and from here markets will be impacted by policy implementation.
As we’ve pointed out many times before, we think the UK’s prospects look pretty good from a macroeconomic and a fundamentals point of view, with UK equities having been through a tough few years. In the lead up to the election we’ve seen decent growth momentum, with some signs that sentiment might be shifting upwards. Low valuations are a key attraction, and if the new government can deliver meaningful upside, that could turbocharge the opportunity.
As mentioned above, a large number of elections took place in June and early July, with new leadership elected in India, Mexico, South Africa and France. While we don’t have the space here to discuss each in detail, suffice to say that our main takeaway is that geopolitical volatility is here to stay, with a lot of surprising results that have resulted in very sharp market movements; both positive and negative.
One upcoming election that we will briefly touch on is the increasingly bizarre situation unfolding in the US, where the Presidential election isn’t until November, but is making headlines for all the wrong reasons.
The chart below shows the odds of various candidates to be the Democrat nominee, where following the disastrous Trump/Biden debate in June, Vice President Kamala Harris (blue line) has surged ahead of Joe Biden (white line).
For now, Biden and his team are still insisting that he’ll stay in the race, but in the background there’s a lot of horse trading around a potential replacement, and with another debate on 10th September still to come, and 4 months to go until the election itself, there will be plenty of volatility to come.
We think this domestic uncertainty adds another layer of risk to high US equity valuations which is why we’re still happy to be underweight the most expensive stocks there.
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Hopes for a so-called ‘soft-landing’ persisted through May, with cooling inflation and signs of improving growth helping to drive gains across all major equity regions, in local currency terms. However, an appreciation of sterling versus most other major currencies weighed on GBP denominated returns.
Once again, performance from commodity markets was strong, driven by rising activity levels and expectations of supply shortages in some key materials – most notably copper, where prices of the metal hit all time high levels, before dropping back as the month came to a close. Elsewhere, ongoing tensions in the Middle East led to a mid-month rally in safe-haven gold.
Across bond markets, the emerging environment of improving growth and falling inflation led to mixed outcomes, as investors struggled to comprehend the trajectory of monetary policy movements. Mid-month reports of moderating US CPI inflation created increased expectations for interest rate cuts, driving down bond yields initially, before strong labour market data pushed yields in the other direction. A month end rally in bond prices was then triggered by a US PCE inflation print that indicated a weakening in consumer spending.
At a global level, correlations between bonds and equities were noticeably high throughout May, indicative of a market that is firmly focused on movements in inflation.
On a regional basis, the US market resumed its positive streak, with the Nasdaq (in pink, above), gaining 5.0% in sterling, benefitting from a set of exceptional results from technology giant, Nvidia. Earnings reports from the chipmaker continue to impress traders, with reported quarter one profits and revenues exceeding analyst predictions. Looking more broadly, ongoing corporate strength, coupled with optimism over monetary policy easing led both the Nasdaq and the S&P 500 (in green, above) to reach record highs through the month.
Elsewhere, the broadening in returns continued, with Chinese equities (above in purple) rallying particularly strongly through the first half of the May, as market participants reacted positively to the latest round of policy driven stimulus and sought to capitalise on the region’s low valuations. Despite exuberance waning towards month end, in GBP terms Chinese equities still managed to eke out a modest 0.3% gain – in local currency terms however, this equates to a more pleasing 2.1%. Wider Asia Pacific (above in yellow) and Emerging Market (in red) equities benefitted from China’s positive performance, albeit sterling denominated returns from both regions were ultimately negative.
Japanese equities (above in dark blue) had a more difficult month as ongoing weakness in the yen weighed on investor sentiment towards the region. In GBP, the Japanese index fell 0.5%.
Closer to home, the UK’s mid cap index, the FTSE 250 (in light blue, above), had a standout month, adding 5.1% and outperforming the large cap FTSE 100 (in orange), which gained a more reserved 1.6%, having posted a new record high earlier in the month. Once again, strong performance from the UK indices is reflective of a broadening market and of investors’ renewed interest in undervalued stocks. As noted last month, this undervaluation of UK Plc. is not going unnoticed, with the pickup in M&A interest in UK companies continuing to create headlines. Through April it was mining giant BHP’s interest in Anglo American that drew the most attention, albeit Anglo have since rejected the offer. More recently, rejected bids for financial services firm Hargreaves Lansdown provided further proof of just how cheap, good quality UK companies are – a factor that bodes well for investment into the region moving forward.
Across fixed income, as noted previously, shifting interest rate expectations drove market movements through May. As the chart above shows, UK gilts (in dark blue) had a volatile month, rising over 2.5% in the early weeks before retreating to close up 0.8%. US government bonds (in black) performed slightly better, with a pullback in yields leading to a reversal of the losses seen during April.
Once again, corporate bond indices outperformed their government bond counterparts, with earnings growth and resiliency across the corporate sector providing credit with an element of protection against swings in interest rate expectations. The global credit index (in purple) added 1.8%.
While the direction of travel that certain central banks are going to take with regard to their key policy rates is becoming increasingly clear – most notably the European Central Bank (ECB) – market movements firmly indicate that for other key policy makers, things remain a lot murkier.
Within the Eurozone, growth data surprised to the upside through the May, while inflation appears to be trending downwards, allowing markets to believe, with an element of confidence, that the ECB will be the first of the major central banks to cut rates, with a cut on June 6th all but locked in by traders.
Looking towards the US and the Federal Reserve (the Fed) though, the picture is significantly less clear.
The release of April’s US CPI print showed a very small cooling in inflation, although the region’s labour market remains tight, leading the Fed to temper its rhetoric around imminent rate cuts. Furthermore, looking at PCE inflation, a broader measure that is known to be the central bank’s preferred metric, there was a slight increase in prices through April, albeit this was coupled with a weakening in consumer spending.
Looked at in combination, recent data releases do point towards a softening in the US inflation picture, however, as the chart below shows, when viewed on a year over year basis, PCE inflation is clearly beginning to stall – and it appears to be doing so at a rate that is somewhat higher than the Fed’s target 2%.
Whether this stagnating inflation picture affects what the Fed does moving forward is yet to be seen, but there is reason to think rates in the US will stay elevated for a little while longer. By way of a reminder, coming into this year, markets were pricing in 1.5% of cuts from the Federal Reserve during 2024. A far cry from the 0.5% that is currently predicted.
Finally, looking at the UK, the picture is different again. Despite falling from 3.2% to 2.3% through April, the region’s most recent inflation print came in above expectations, with the drop driven in its entirely by so called ‘base effects’. As such, with inflationary forces still at play across the UK, the scope for a June interest rate cut from the Bank of England is limited – a point that is particularly important in the context of the general election on July 6th, as the Bank will want to ensure its actions are not viewed as being in any way politically motivated.
Needless to say, as we move into the summer months, we expect volatility across markets to continue, given ongoing uncertainties around interest rates, inflation levels, and the political landscape. However, current data indicates that global growth is beginning to pick up, corporate earnings are improving and valuations in a lot of areas remain very attractive, all which provides us with plenty of room for optimism.
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Starting with bond markets, we saw negative returns for all the major bond indices across April. Largely this negative performance was driven inflation by data which came out during the month, particularly relating to the US and the UK, and which was a little higher than expected. This led investors to push back expectations relating to rate cuts made by the Federal Reserve and the Bank of England. In the US, we saw the March Consumer Price Index (CPI), a key measure of inflation, come in at 3.5%, which was higher than the 3.4% expected. This was the third higher than expected CPI report in a row for the US, and showed that inflation across the pond is remaining stickier than many had expected; particularly services related data which is being supported by a very strong labour market.
European bond markets performed better on a relative basis during April, as their inflation data came in as expected. European CPI for March was 2.4%, which was the same as the February meeting and keeps them quite close to the target level of 2%. The economic backdrop for Europe is also much weaker than we are seeing in the US, and while we are seeing improvements, the market is currently pricing in around a 70% chance that the European Central Bank cuts interest rates in June.
Closer to home, we saw CPI for the UK fall to 3.2% for March, falling from the 3.4% we saw in February and continuing a nice downward trend, as you can see from the chart below. However, the market was disappointed as, like the US, this did not fall by as much as was expected. The key issue being that services related inflation, the blue bar in the chart below, was remaining quite sticky, and that this is the hardest part of inflation for the central banks to influence.
Source: Oxford Economics
The US economic data points towards the potential of interest rates staying higher for longer. Particularly given the strong economic backdrop and the potential risk of inflation increasing at a higher rate were we to see interest rates lowered. In the UK, the weaker economic backdrop arguably means that rates could be lowered from the current level to support growth, while not causing inflation to increase. Despite the higher than expected reading for March, investors are still hopeful for a rate cut by the Bank of England coming within the next couple of meetings.
The change in expectations relating to interest rates was also one of the key drivers of the equity market during the period. April ended as the first month of negative returns for the US equity market, as measured by the S&P500, since October of last year. Given the very high weighting that US equities have in the global index, this dragged down the MSCI World, which finished down 2.9% in GBP.
The worst performing of those shown in the above graph (all returns shown in GBP) was the MSCI Japan index, which fell 3.6%, having been a very strong performing market over the past 12 or so months. However, this was largely driven by further weakness seen in the Japanese Yen, as the market was only down 0.6% in Yen terms. Given the low interest rates in Japan, the likelihood of rates staying higher for longer in markets such as the US and the UK is weighing significantly on their currency’s exchange rate. So much so that during April we saw a joint statement by US Treasury Secretary, Janet Yellen, along with her Japanese and Korean counterparts acknowledging serious concerns relating to sharp depreciation of their currencies. This lends investors to think that the Bank of Japan (BoJ) will step in to intervene with the currency, and that this is supported by the US. This has temporarily supported the Yen, but concerns remain about how much further the BoJ is willing to go to support their currency, or raise interest rates, or even whether they have the ability to do so.
As we already mentioned, US equities were weak during April, with the broader S&P500 losing 3.3%, which was marginally better than the 3.6% loss for the technology heavy NASDAQ. Unlike Japan, this was not due to currency volatility, as local returns, in USD, were weaker than those shown above in GBP. The weakness in the US market was driven by the higher for longer narrative around interest rates, which suggests that the Federal Reserve have a trickier job than other central banks. This also impacted the US more than other markets due to the higher valuation that the US market carries, particularly give the strong performance we have seen from US equities over the last 18 or so months. US earning season for Q1 2024 has also been in full flow, with the majority of the market reporting during April. This was a relatively uneventful earnings season, with the majority of companies performing in-line with expectations. It is clear to see though that the market is laser focussed on future guidance, with this being the more dominant driver of share prices following earnings announcements.
On the positive side of things, we saw Chinese equities as the best performer this month, gaining 7.6% and helping lift broader Asia Ex-Japan and Emerging Market indices. The FTSE100 also performed well, gaining 2.4%, which pushed it through the 8,000 level to hit all time highs. Patience of those invested in the UK therefore beginning to be rewarded, while valuations for the UK market still looking attractive. The FTSE was helped by strong performance in commodity related equities, particularly the miners, which have seen quite significant price increases of the underlying commodities they are associated with. This positive sentiment was given a further boost when BHP Billiton, the once UK listed miner who now trades on the Australian Stock exchange, bid for the UK listed Anglo American. The first offer was for $39bn, which was rejected by Anglo American, and investors are now weighing up whether increased bids are likely to follow, or who else might be targeted.
We discussed precious metals in detail last month, but April was another good period for both silver and gold spot prices. Both of these are also included in the chart above, with gains of 2.5% and 5.3% to gold and silver respectively. Both metals were on for a much stronger gain before they pulled back a little over the last 10 or so days of the month. This pull back was likely driven in part by the changing in rate expectations that we have already discussed.
To conclude, we feel that April has shown that we are still seeing many economies see inflation at higher levels than we thought it might be at the start of the year. This is causing volatility in expectations around interest rates, when they may be cut, and how many rate cuts we can expect in the next 12 months. This is causing ripple effects across major equity and bond markets. We therefore continue to believe this highlights the importance of diversification, particularly given the ongoing geopolitical uncertainty and all the elections that we have this year.
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Additionally, we have seen extraordinary strength within the precious metals space in recent weeks, as the prices of gold and silver have rocketed alongside associated mining equity prices, per the first chart below. Silver (light green line) rose by more than 15% during March, with gold (black line) up 11.5% also far outpacing equity markets. As could be expected, precious metals mining companies’ returns – which are a higher beta play on the precious metals space – were even stronger; over the month silver miners rose by 31.5% and gold miners by 25.0%.
Intriguingly, precious metals have been rising despite ‘normal’ conditions for a run up not being in place; the US dollar has been strengthening, while inflation adjusted government bond yields have also been rising, neither of which should be good for gold nor silver prices.
Indiscriminate global central bank purchases are the most likely cause of the recent strength, with notably China and India steadily and in large size adding to their gold reserves over the past 18 months. Many reasons have been offered as to why – perhaps central banks are worried about the US dollar’s role as an economic weapon vis a vis the treatment of Russian assets as a result of their invasion of Ukraine, or perhaps they are worried about the re-emergence of inflation.
Regardless, should the prices of the metals continue to increase, we can reasonably expect mining equities’ prices to also increase, and given this part of the market is extremely cheap with outstanding operational leverage, we see the space as a good diversifier looking ahead.
Excluding precious metals, the best performing equity region this month was the UK. The mid cap, domestically focused FTSE 250 (light blue line) and the FTSE 100 indices (orange line) both performed very strongly, rising by 4.4% and 4.0% respectively, and were driven by some of the positive macroeconomic factors we wrote about in detail last month; PMI surveys continue to show signs of strength in both the services and manufacturing sectors, GDP has returned to positive territory, the labour market remains strong, and inflation continues to surprise to the downside. Notwithstanding the political volatility we might see later this year, we still think the UK is in a good spot, and equities remain cheap.
Elsewhere, at the bottom of the performance rankings this month were Japanese equities, only rising by 0.9% over the month after taking a break from a powerful run up, and the US tech-focused Nasdaq index which rose by 1.3% during the month.
Of course this is only a 1 month time period, but as mentioned above, what we have begun to see is a wider participation in risk asset positivity, which is beneficial for those invested in other asset classes that perhaps haven’t performed as strongly over the last year, and perhaps an early warning for investors heavily concentrated in previous winners.
To illustrate this, the second chart below quite simply illustrates the notion that momentum simply cannot last indefinitely. It shows the subsequent forward returns for the 10 largest US companies over various time frames in absolute terms (black bars) and relative terms versus the S&P 500 index (blue bars), going back to 1980.
The obvious takeaway message is that while these companies do usually continue to generate positive absolute returns on a forward looking basis, their returns relative to the wider index deteriorate to a greater or lesser extent as time moves on; today’s top firms may continue to lead the market in the near term, but we think investors seeking diversification and alternative sources of alpha may find opportunities elsewhere.
Turning to fixed income, the third chart below shows bond index performance over March, where we can see what was looking like a fairly positive month sharply reversed as investors adjusted their expectations for interest rate cuts:
Best performing again were corporate bond indices which were swung around less by these changing expectations, with government bond indices drawing down much more sharply into the end of the month. The cause of this was various indicators relating to labour markets coming in hotter than expected, and some central bank economists intimating for the first time that if economic data remained hot, that perhaps interest rate cuts might not be needed at all in 2024.
For now, in the US which remains home to the world’s most important central bank, official forecasts as of March were for growth to remain strong, for inflation to fall though remain above target, but crucially for interest rates to still be cut 3 times this year. It seems that the Federal Reserve and other central banks believe policy is restrictive and rate cuts will reduce the amount of downside risk to the economy in the future. They may well be right, but it is still an open debate as to whether policy is as restrictive as they think. Financial conditions have eased significantly since the end of October, with for example the housing market, a key interest rate sensitive sector, rebounding strongly over the last couple of months.
Needless to say, markets like hearing this pro-growth bias from central banks, however, as you can see from the chart above, these same markets still have a reaction function and do not like seeing macroeconomic data surprises that imply an invalidation of their thesis.
As we look ahead into the second quarter of 2024, market conditions have become more fractious, with geopolitical tensions bubbling to the surface again in the Middle East (if indeed they had ever gone away) as Iran attacked Israel. Volatility is elevated across asset classes, which is something we expect to persist, though close attention will still need to be paid to macroeconomic data releases in the coming months given investors’ focus on them, and their importance to the continuation of the current market narrative drivers.
As we have written many times before, there remain plenty of opportunities across different asset class, but as always, diversification will remain key as we try to navigate this highly changeable market environment.
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February saw a bifurcation between equity and bond returns, with generally positive moves for global equity markets driven by strong corporate earnings reports, while fixed income came under pressure again as economic data remained resilient and expectations for interest rate cuts were pushed further out into 2024.
The first chart below shows equity market returns in pound terms during February, with outliers to the up and downside. One positive story to immediately pull out here is that of Chinese equities (dark purple line), where we saw a gain of more than 9% during the month. Having hit a five-year low coming into February, activity data over the Luna New Year holiday period showed good strength, and this, combined with more supportive interventions from the Chinese government boosted sentiment.
Given how far the Chinese index has fallen over the last year, this barely moves the dial in terms of relative returns, and valuations remain extremely cheap, but with the news getting less bad, we see this as a positive development, and we remain optimistic on the region’s prospects.
As written about last month, the Chinese government have been steadily introducing explicit and implicit stimulus and stabilisation measures, including restrictions on securities lending for short selling, easing of real estate restrictions, greater access to credit for real estate related companies, and the possibility of sovereign bond issuance to fund national projects. China’s National People’s Congress is taking place at the time of writing, and with growth targets and strategies often announced here, we can reasonably expect support to continue to flow.
Elsewhere, somewhat inevitably, we saw strong performance from US equities broadly (green line) and from the growth and technology-focused Nasdaq index (pink line) in particular, returning 6.0% and 7.0% respectively. During the month we saw quarterly earnings results from the ‘Magnificent 7’ tech stocks, which resulted in some extraordinary performance from a couple of members of this exclusive club; Meta and Nvidia.
Meta jumped by 20% on its 2nd February results day, which was the largest one day market cap gain for any stock in history, before promptly being beaten by Nvidia a couple of weeks later which itself jumped by around 16% on its own results day, adding some $277bn of market cap in one day. To put that into context, $277bn is over $20bn more than the market cap of the entire UK listed investment trusts universe of c.$250bn, and not far off the entire FTSE 250’s market cap.
These largest technology-focused companies’ share prices have been driven by the AI narrative over the past year, but despite strong earnings reports, expectations for future growth keep moving higher. Per the chart below, the largest ten stocks in the S&P 500 are trading on a multiple of roughly 30x forward earnings, with these earnings already expected by investors to expand much faster than the rest of the index. This compares to around 18x forward earnings for the remainder of the S&P 500, where earnings expectations are more modest, but still in themselves elevated in absolute terms and relative to other regions.
Meeting these earnings expectations will in part depend on whether AI lives up to current hype. While the speed of rollout and adoption of AI is impressive, its eventual impact is hard to confidently forecast at this stage:
Finally in equities, the UK performed relatively poorly during the month following a -0.3% (quarter-on-quarter) fourth quarter GDP print that showed the UK falling into a technical recession in 2023. Despite this, we think that the fundamental and macroeconomic backdrop for the UK is positive; the labour market is strong, the housing market seems to be picking back up again, consumers have got a lot of savings they can still deploy, and important leading indicators are strong, indeed stronger than most other major nations.
In fixed income, once again high yield bonds (yellow line), which of course are much more closely linked to equities than government bonds in terms of their risk return profile, outperformed, while more traditional government and investment grade corporate bonds underperformed, as we saw signs that inflation might not be completely under control continued, and central banks started to push back on rate cut narratives given continued economic strength.
Given the recent strength in economic data, we have seen a repricing of investors’ expectations with regards interest rate cuts as the chart below shows, which was the main driver of weakness particularly in the government bond space. The chart highlights the pathway for US interest rates that investors now expect (red line) vs what was expected at the end of December 2023 (blue line), with fewer and later rate cuts now priced in.
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Discover more insights from our Divisional Director, Peter Donaldson, and Investment Manager, Imogen Hambly as they delve deeper into last month’s market update.
In contrast to the broad-based rally that we saw in markets through Q4 2023, asset class returns were far more mixed during January, as investors sought to reassess their interest rate assumptions, pushing back the expected date of that all-important first rate cut.
Across developed markets, data releases continued to show economic resilience, with consumers still spending, housing markets still active, and government stimulus packages providing ongoing support to the corporate sector. Strong activity levels led inflation to surprise to the upside in December, although it remained on its downward trend. This offered sufficient evidence to support interest rate cuts through 2024, but forced traders to rethink when those cuts will begin, with central bankers eager to ensure they do not cut rates too early and reignite the fire of high inflation.
Against this relatively positive macroeconomic backdrop, equity markets returned a varied set of results, with the global equity index gaining 0.7% in sterling terms.
While developed markets were generally buoyed by the encouraging growth data, issues within the Chinese market led to losses across broad emerging market and Asian equities, despite announcements by the Chinese Communist Party (CCP) and the People’s Bank of China (PBOC) of a range of new stimulus measures.
Within fixed income, the re-adjustment in interest rate expectations weighed on returns from government and corporate bonds, with the global aggregate bond index falling 1.3%, in GBP, through the month. Other rate sensitive areas also struggled as short-term bond yields moved up. Most notably, real estate and small-cap equities both posted losses.
As tensions escalated across the Middle East, commodity markets performed well, with the Bloomberg Commodity index gaining 0.5%, in pound terms, and global oil prices rallying. Despite ongoing disruption through the Suez Canal and the consequent impact to global shipping, for now, aggregate commodity prices remain below levels seen at the start of the Israel – Gaza conflict.
As the chart above shows, at a regional level, Japanese equities (in dark blue) retained their upward momentum from 2023, outperforming other regions and gaining 7.0% in local currency terms, or 4.7% in sterling, with the strength of the pound weighing on translated returns. Across Japan, stocks are continuing to benefit from positive investor sentiment, driven by a number of factors, including low inflation, a positive growth outlook, and policy driven corporate reform.
Elsewhere, the US technology index, the Nasdaq (in pink), had another strong month, gaining 4.6% in GBP and driving the broad US S&P 500 index (in green) higher. From an earnings perspective, recent results indicate a general decline in US profit margins through Q4, however from a macroeconomic standpoint, data continues to hold up well across the region, with employment and wage growth figures pointing towards a robust labour market, while December’s GDP print came in above consensus expectations. In combination, although downside pressures are beginning to filter through, optimism around a ‘soft-landing’ scenario still appears to be supporting the region’s stock market.
Across Europe and the UK, the prospect of higher-for-longer interest rates weighed on returns. European equities (in light purple) were positive in local currency terms, but flat in pound terms, while UK equities gave back a portion of the gains we saw through the latter months of last year.
As noted previously, it was another difficult month for the Chinese market (in dark purple), with equities failing to show any kind of positive price action. The aforementioned policy announcements made by the government and the PBOC through January were designed to provide support to the economy, the real estate sector, and the stock market. However, despite their best intentions, the short-term effect of the policies was to underscore concerns about an economic recovery that is being hampered by an ongoing property crisis, deflation, and weak consumer confidence. Poor performance from China filtered through to the broad Asia ex Japan (in yellow) and Emerging Market (in red) indices, where GBP returns through the month were -4.0% and -3.7%, respectively.
In bond markets, it was a return to the trend we saw through 2023 with high yield and global credit outperforming government bonds, as traders sought to balance the ongoing strength of economies with falling inflation data, ultimately parring back their bets on Q1 interest rate cuts and leading government bond yields to rise.
As the chart above indicates, the move upwards in government bond yields hurt much of the fixed income space, notably US Treasuries (in black) and UK gilts (in dark blue), which fell -0.4% and -2.2%, respectively. The Global High Yield index (in yellow), however, rose 0.3% through the month, benefitting from the more positive macro picture, and the resulting reduction in spreads. US Credit (in pink) also outperformed, eking out a positive return of 0.1%. Again, this comes as a result of reported economic resilience across the US.
Ultimately, the month saw market participants interpret the strength of the economic data as a clear indication that rate cuts are not yet required. Consequently, it was no surprise that central banks across the US, UK and Europe held interest rates steady, with, US Federal Reserve Chair, Jay Powell, turning uncharacteristically specific in his January press conference, stating that a rate cut as early as March is unlikely.
In spite of the more hawkish tone adopted by central banks through the month, it is still generally accepted that inflation levels are falling back to target, as shown below, and while aggregate GDP growth levels are slowing, economies are not likely to enter into deep recessions – meaning rate cuts can come during 2024, and they can do so at a considered pace.
Per the above, there is little denying that the inflation picture is beginning to look relatively healthy, with both core and headline figures moving in the right direction across emerging and developed markets. January has however drawn a spotlight towards the inflationary risks that are present in within the global economy right now.
Commodity prices provided a strong disinflationary force through the latter months of 2023, with falling energy prices benefitting corporates and individuals alike.
Year to date though, escalating tensions across the Middle East and Red Sea have not only pushed up oil prices, but have added to shipping disruptions, with delays and rising costs beginning to intensify.
Encouragingly, corporates are so far managing to absorb these inflationary impulses through healthy inventory levels and well diversified energy systems. What’s more, Western economies are now benefitting from imported Chinese disinflation. As such, while activity levels in China remain depressed, it is likely that goods and commodity prices in the region are going to continue to fall and China will remain a disinflationary force, able to counteract the more inflationary geopolitical factors.
After what was an exciting end to 2023, the new year has started with a little less enthusiasm as investors have sought to digest the implications of December’s strong activity data, against a backdrop of falling inflation and mounting geopolitical risks. Despite this pick up in volatility, there remain plenty of opportunities across different asset class, but as always, diversification will remain key as we try to navigate this highly changeable market environment.
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Gain a comprehensive overview of the market’s unexpected twists and turns, followed by a look into what to anticipate in the coming year.
Many readers will remember that coming into 2023, it was consensus from economists that we would see some, if not all, of the developed world enter a recession. A poll by the FT showed that in December of 2022, 80% of economists polled thought that we would be in a recession by the end of 2023, while some thought we were already in one at the time. We can now safely say that those predictions were wrong. Instead, throughout 2023, we saw unemployment stay low, consumer spending remain resilient and revisions for full year GDP, particularly in the US, revised consistently upwards.
So, the recession never came and economic data across the developed world was better than expected. This therefore sets up for a good backdrop for equities – and it turns out, despite not feeling like it for much of the year, that 2023 was a good year for most risk assets. Below, we are showing returns, in sterling, for some major indexes across the full year. We have the Nasdaq that gained 46%, driven by excitement around Artificial Intelligence (AI) and the hope that we will soon be seeing lower rates in the US as inflation came under control. Followed by the, also tech heavy, World Growth index at 32%, then the broader S&P with a gain of 17%, India, Japan and Europe around 13%, global smaller companies at 9%, the FTSE 100 at a lower, but respectable, 8%, and then emerging markets up 4%. Asia finished flat and then the major outlier of Chinese equities, down 16%.
2023 has just shown how difficult it is to predict markets and economies, particularly as we still unwind issues from the pandemic and the considerable stimulus that came with it. We simply just don’t have precedent for an environment like this and how it may affect asset classes. So, despite many major events happening, accompanied by lots of very negative headlines, equities actually performed pretty well. The key therefore is to remain invested, stick to long-term planning, and allow the power of compounding to work in your favour.
As previously mentioned, a lot of the gains in markets this year have been driven by the rise of Chat-GPT, and what that could mean for wider use of AI advancements and who the winners of that story would be. Thus far, the main winners have been named as the “Magnificent 7”, which as a group consists of Apple, Microsoft, Alphabet (Google), Nvidia, Amazon, Meta (Facebook) and Tesla. These 7 stocks are now the 7 largest in the global equity index, accounting for 30% of the US index, and as a group gained around 106% (in USD) in 2023.
Turning to fixed income, much like equities, bonds battled through a difficult and volatile year, but ended in positive territory across all major indexes that we are showing below. The best performing index here is high yield bonds, gaining 13.7%, which came as a surprise to most investors, as this was an asset class many expected to be weak this year. This is a similar story for the equities, given the poor sentiment in this asset class coming into the year, economic resilience has really boosted returns of those invested. We have seen defaults rising through the year, but remaining low in context of history. However, despite this strong run, investors do remain somewhat cautious of high yield bonds due to spreads being very narrow compared to history and the difficulty it will likely face if the economy does begin to roll over.
We then have sterling credit, gaining 9.5%, global corporates up 9.1%, US corporates up 8.1% and European corporates up 7.5%. Again, benefitting from attractive starting yields and boosts from economic resilience.
The laggards are sterling Gilts, which rallied very strongly from November to end positive, having spent most of the year in negative territory, and up 3.4%. Around the same level of returns from US treasuries and slightly behind the global index-linked market.
As we look out to 2024, we enter with cautious optimism across equity and bond markets. The key question remains whether we have pulled forward a lot of the good news from 2024 into 2023, and whether we may still get the economic impact of the rate rises felt across the economy. Or whether we will truly enter a new growth cycle and the market has every right to be optimistic.
All eyes will continue to be focussed on inflation, unemployment and GDP growth, as a guide as to where central bank interest rates may be headed. Current consensus is that inflation will continue to move lower through this year, in a fairly stable manner, with the US and Europe ending the year close to the 2% target, and the UK still a little higher. Investors therefore hope that this will allow central banks to declare victory on their battle with inflation, and lower rates to a less restrictive level. Markets are currently pricing in around six 0.25% cuts in the US across 2024, which is double the guidelines provided by the Fed. The market is also expecting these cuts to happen in the first half of the year, maybe even in March, whereas the Fed has suggested they would come closer to the end of the year.
However, it remains key to understand what the cause of these cuts could be, as markets will react very differently based on whether the cuts are coming from a strong economic backdrop while inflation remains low, or whether we will need to cut rates to support a weaker economy. Many strategists are also making the point of why we would even want rate cuts if the economic data is still strong with low inflation, and that central banks might leave that option in their back pocket for any future issues that will inevitably crop up.
Entering 2024, we have valuations of equities looking fairly cheap in many regions, particularly the UK and Emerging Markets, which trade at a discount to the rest of the developed world and when compared against their long-term averages. We also have bonds providing very attractive yields, even at the lower risk end of the market, which should provide a good level of support for balanced portfolios. This provides investors with a relatively positive backdrop, alongside tailwinds such as AI, the green transition and potentially lower interest rates. We therefore continue to strongly believe that it is key for investors to remain diversified, and that while there are reasons to be more cheerful, there are still significant risks at play. Particularly given the fact we have both UK and US general elections likely to happen in the final quarter of the year.
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The positive sentiment from November carried on through December, as both equity and bond markets ended the year in in good spirits. The global equity index ended up 4.3%, which combined with the growth in November led to gains of 14% in the final two months of the year.
The significant driver of the returns for both bonds and equities was due to the continued downward trend of inflation seen across key markets. It was a similar story as to last month, with investors cheering the idea of inflation steadily moving back towards central bank target levels of 2%. This month’s numbers showed that in the US, inflation fell again to 3.1% from 3.2% in November, which led to the Federal Reserve (Fed), in their December meeting, outlining that rate hikes in the US are likely to now be behind us, and that we might see rate cuts in 2024.
Closer to home, we saw both the Bank of England (BOE) and European Central Bank (ECB) hold rates steady, following similar positive data relating to their inflation readings. UK CPI fell to 3.9%, from 4.6% in the previous month, whereas in Europe, headline inflation fell to 2.4%, the lowest figure for 2 years.
As the chart above shows, the strongest equity market in December was again the FTSE 250, gaining 9.2%, which replaced November as the strongest month of the year for the index. Elsewhere in the UK, the FTSE 100 also performed well, gaining 3.7%, which put it in the middle of the pack.
Continuing the trend of the year, we also saw strong performance from the technology heavy Nasdaq index, gaining 5.5%, with the wider S&P 500 not far behind at 4.4%. The S&P actually finished the year on a streak of 9 positive weeks in a row, the longest since 2004. This meant that as we closed out 2023, we sat with those two indexes trading very close to all-time highs. Asian equities also performed well, gaining 4.5%, following a rally in the last week of the year. The story was the same for Emerging Markets, which finished in line with European equities in gaining just below 4%.
The laggard was China, which despite a late rally lost 2.6% in December. We also saw Japanese equities lagging, with a fall of 0.6%, following a very strong year for that market.
Much like equities, major bond indexes also finished the year very well, as shown in the graph above. It was a very good month for UK based bonds, with Gilts as the best performer, gaining 5.8%, followed by sterling corporate bonds which gained 5%.
We then have a cluster of indexes all increasing in the low-to-mid 4% range, which includes global inflation-linked bonds, global high yield, as well as global and US corporate bonds. Assets that still performed well but lagged were US treasuries at 3.4%, and European Government bonds and Corporate Credit which gained 3.6% and 2.7% respectively.
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Positive sentiment was seen across global markets through November, with the global equity index closing up 8.1%, in what was the best month for equities in three years. Across developed markets, early signs that inflation levels are moderating and will retreat back to target levels through next year are providing investors with a good deal of confidence. Furthermore, recent data releases continue to reflect economic resilience, helping to reinforce the view that central banks have reached a peak in their rate hiking cycles, and may in fact move to cut interest rates sooner than was previously anticipated.
This adjustment in interest rate expectations provided a positive boost for both government and corporate bonds, leading the global aggregate bond index to gain 5.0% through the month. With bond yields in retreat, growth-oriented equities outperformed their value counterparts, while small- and mid-caps also rallied.
Elsewhere, movements in bond yields benefited real estate equities – however commodity markets suffered through the month. Despite ongoing tensions across the Middle East, elevated levels of oil output from both the US and the OPEC+ nations pushed the oil price lower, providing another source of positive impulse for global equities.
Gold was a notable outlier within the commodity index, continuing its upward trend from last month and closing November at a level very close to its all-time high. Throughout 2023, the gold price has shaken off the negative price pressures associated with higher real yields, instead rallying on the growing level of demand that has come from central banks looking to diversify their reserve assets.
As the chart above shows, equity returns across most major regions were positive, led by the UK’s mid-cap biased FTSE 250 index (in light blue), which posted its best month of the year, adding 6.9%. In contrast, the UK’s large cap index, the FTSE 100 index (the orange line), had a somewhat more lacklustre period, posting a modest gain of 1.8%, with the latter’s tilt towards commodities and value equities driving its relative underperformance.
In the US, the technology-heavy Nasdaq index (in pink) benefitted strongly from the pull back in bond yields, adding a further 6.6% (in GBP) through November. In local currency terms the Nasdaq gained almost 10.7% through the period, with the broad S&P 500 index (in light purple) also gaining a very respectable 8.9% in USD – however, a strengthening of the UK pound versus the US dollar led UK investors to experience lower translated returns.
Chinese equities (dark purple line) had another difficult month, falling 1.4% in pound terms and bringing year to date returns to -13.5%. While the region’s stock market continues to come under pressure from slowing growth, it would be remiss to forget that China is an $18 trillion economy, that is highly integrated into the global market. Its dominance pans numerous sectors, with the country responsible for the manufacture of 80% of the world’s solar panels and in control of 75% of global battery cell production. It is not, therefore, a region that should be written off as the result of a period of sub-par returns.
What’s more, November played host to a much-anticipated meeting between Chinese President Xi Jinping and US President Joe Biden. Tensions between the two regions have been running high for some years now, but early reflections on this meeting show it to have been constructive – with agreements made relating to climate change and military cooperation. Although this leaves countless trade barriers in place between the two countries, the direction of travel here is important, and in the longer term should help boost both Chinese, and global, equity markets.
In fixed income, falling yields led to strong price rises across the asset class. Having noted last month that yields on US 10-year Treasuries pushed above 5% for the first time since 2007, late November saw them fall back below 4.4%, reflecting the market’s growing conviction that the Federal Reserve will begin cutting interest rates as soon as March 2024.
This drop in government bond yields swiftly filtered through to corporate credit, as the above chart indicates, with US corporate bonds (in pink) outperforming and posting gains of 6.0%. Strong data releases, indicative of positive economic momentum, also benefitted investment grade and high yield credit, with spread compression seen across global bond markets. While recent months have seen spreads on US corporate bonds trade in line with their 20-year medians, November’s strong performance has led to a narrowing in spread levels, again suggestive of the market’s positive outlook for the US economy as we move towards the new year.
At both a corporate and government level, movements in European bond prices were slightly more subdued through the month, albeit gains were still made. While inflation across the Eurozone is clearly retreating, growth in the region remains depressed, with manufacturing activity data still sitting deep into contractionary territory and reports that European corporates are beginning to react by reducing staffing levels for the first time since 2021.
However, per the above chart, if we look out to next year, GDP growth across the Eurozone is expected to turn a corner and post an increase, as compared to this year – bucking the trend of other global regions. What this indicates, is that different regions are now at different stages in their respective cycles, which as we move through 2024, will provide an element of support to global growth as a whole.
From an investment perspective, we look to this as a source of optimism. Not only are we nearing the bottom of the cycle in some areas, but subdued stock market returns across numerous regions mean attractively valued, high quality companies, are not hard to find. While volatility will also certainly remain elevated, by retaining a clear focus on quality, valuation and upside potential, we believe there are ample reasons to enter the new year with an element of positivity.
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Discover more insights from our Divisional Director, Peter Donaldson, and Investment Director, Oliver Stone as they delve deeper into last month’s market update.
There was little positive news in October for equities. As the first chart below shows, equity indices fell to a greater or lesser extent through the month. Losses were driven by the prospect of ‘higher for longer’ interest rates which hurt equity valuations, while the Israel-Hamas conflict dampened risk appetite. Developed market equities outperformed emerging market equities over the month, growth stocks proved relatively resilient versus their value counterparts, and large-cap companies outperformed small-caps, all of which continued the trend of 2023.
Commodities were a notable outperformer during the month, with prices reversing some of their year-to-date losses on the back of the tragic events that unfolded in the Middle East. Oil prices rallied amid concerns that an escalation into a wider regional conflict could disrupt oil supply, but most notably we saw a flight to gold as a safe haven, whose price rose by 8.5% in pound terms (black line).
The gold price is currently hovering around the $2,000/oz mark again despite real interest rates and the US dollar having moved higher, showing that it’s still a genuine hedge for geopolitical risk:
Europe (purple line) was marginally the best performing region, just pipping the US (green line) to top spot despite falling by around 2%, with UK large-caps (orange line – FTSE 100) also there or thereabouts in falling by 2.5%. US indices wobbled towards the end of the month as some of the “Magnificent 7’s” Q3 earnings reports disappointed investors, but they rallied into the end of the month and have started November extremely strongly.
October saw a flurry of data signalling the resilience of the US economy, including a blockbuster jobs report, strong retail sales data and a blowout GDP print of 4.9% annualised for the third quarter. Inflation came in hotter-than-expected, with the headline figure flat at 3.7% year on year in September, against expectations of a slight moderation.
Chinese equities (dark purple line) were weak once again, falling by 4.5% despite there being some positive upside surprises in their third quarter GDP numbers, industrial production and retail sales. Nonetheless, continued weakness in the real estate sector, and reports of new US restrictions on AI chip exports to China further dampened market sentiment, and China’s poor performance dragged down the MSCI Asia ex-Japan Index (yellow line) and the MSCI Emerging Markets Index (dark orange line), which both fell by mor than 4% on the month.
In fixed income, returns from US-focused indices were negative, but we saw brighter spots elsewhere, as the second chart below shows. During the month the US 10-year Treasury yield pushed above 5% for the first time since 2007, driven by a combination of buoyant economic data making ‘higher for longer’ rates look increasingly likely, and concerns around the sustainability of government finances. A move higher in yields was seen throughout the global government bond market and in credit, widening spreads dented monthly returns for both investment grade and high yield bond markets.
US Treasuries (black line) fell by 0.65% during the month, with similar losses seen for global investment grade corporate bonds (purple line) and high yield bonds (yellow line); both of which indices are dominated by US exposure.
But elsewhere there were positive returns, with European (green line) and UK government bonds (dark blue line) outperforming, and rising by 0.86 and 0.66% respectively, after central banks paused rate hikes again during the month.
Outside of financial markets, attention was fixed on the tragic events unfolding in the Middle East where a surprise attack was carried out in early October by Hamas on Israel with truly appalling, indiscriminate killings of civilians and hostage taking, which has resulted in a strong retaliation by Israel via a ground invasion of Gaza.
The key question for investors is to try and understand how widely the conflict will spread, and what impact it may have on global markets, with the third chart below from the team at Alpine Macro succinctly illustrating a range of potential scenarios that are probabilistically weighted:
The Alpine team ascribe a 70% probability to the first scenario at the top of the chart unfolding – a limited regional escalation – which will and has seen an Israeli ground invasion coupled with already mounting international pressure to limit the conflict as casualties mount. There will and have been threats from other regional actors – namely Iran and Hezbollah – to escalate, but this scenario expects minimal regional escalation, avoiding a major regional war.
The rationale for this is that the U.S. has already deployed significant naval and marine forces to the Eastern Mediterranean, providing a deterrent, and that despite most Arab states supporting the Palestinian cause, there is little appetite for an expanded war, or for that matter a victory for Hamas, Hezbollah, and Iran.
Moving to the second and third scenarios, these carry a much higher level of risk and could create significant market turmoil. While they do carry a low level of probability, scenarios that involve an escalation of conflict drawing in more actors, and particularly ones that directly involve Iran, must be considered given the potential impacts on notably the global oil price. Any attack on Iranian infrastructure and resulting escalation would disrupt Persian Gulf oil exports, and potentially draw the U.S. into the fray.
For now, there has been limited escalation outside of the main protagonists, but risks remain, and regardless of any market outcomes these events add to the wave of geopolitical risk we’re seeing unfolding more widely.
Looking ahead to the final months of 2023, it remains key to be diversified across asset classes, strategies and geographies as volatility is likely to remain elevated. October saw major central bank meetings take place in Europe, UK, US and Japan, with governors all ‘pausing’ interest rate hikes, but still at pains to point out their fight against inflation is not yet won, and to expect rates to remain higher for longer.
The lagged effects of much tighter monetary policy globally are still only slowly starting to filter through to the real economy, and market conditions may well continue to be fractious. Despite this uncertainty, we still see many good looking opportunities across the financial landscape, particularly within unloved parts of the equity market which should play out over the medium term and reward patient investors.
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The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guide to the future. The views expressed in this publication represent those of the author and do not constitute financial advice.
