Investment commentary
Q1 2023 Investment Commentary
Home Linkedin Facebook Youtube Instagram Envelope Table of Contents In Brief Q1 2023 was generally positive for global markets Economic
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July saw yet another round of higher inflation prints across major economies. This prompted further central bank rate rises by the US (another 0.75%), and a first increase from the ECB (0.5%), taking the euro area out of a negative rate environment for the first time since 2014. Concerns about higher rates causing a fall in global growth continued to build with provisional data suggesting that the US might already be in a recession. Interestingly, markets had been ahead of this news and so rose given expectations that any economic weakness would allow central banks to be less aggressive in hiking rates than priced in. This meant longer dated bond yields fell and their prices rose, giving positive returns for fixed income investors. Equity markets also bounced, led by Growth equities, whose valuations tend to be more closely linked to lower interest rates.
August saw further central bank rate rises. Although the US didn’t have a policy meeting, a speech by US Federal Reserve Chairman Powell in late August reinforced messaging around the Fed’s determination to continue to raise rates to reduce inflation. Inflation did show signs of slowing in the US, although it continued to tick up elsewhere as further Nord Stream gas pipeline disruptions by Russia pushed gas prices towards all-time highs in Europe. A trip by U.S. House Speaker Nancy Pelosi to Taiwan raised geopolitical friction between the US and China, but these worries were largely eclipsed by inflation, rates and gas price worries by the end of the month. These higher interest rate expectations resulted in bond prices falling as well as negative equity returns on fears of a possible recession.
September saw the sad passing of Queen Elizabeth II at the age of 96, with the UK nation (and wider world) mourning her in the lead up to her state funeral. Later in the month, the Federal Reserve in the US, the Bank of England and the European Central Bank all hiked rates in response to stubbornly high inflation. US inflation in particular fell less than hoped, bringing about expectations of more and faster rate rises in the US. In the UK, the effects of Chancellor Kwarteng’s mini budget were anything but mini as a multitude of unfunded tax cuts spooked markets. The announcements caused large gyrations in the pound as well as UK bond market falls which also extended into global markets. This forced the Bank of England’s hand into urgently intervening as a buyer in gilt markets to protect the UK pension industry, a victim of rapid falls in UK bond prices. Markets struggled to digest the month’s economic news, with bond & equity prices falling globally.
Overall, the third quarter saw poor performance across most asset classes due to aggressive central bank hiking, although falls in the pound did support the performance of overseas equities when converted into sterling. This was particularly true of those asset classes denominated in strengthening dollars, such as US equities and some commodities.
Volatility, as measured by the VIX index, rose over the quarter. Developed market equities (as measured by the MSCI World Index including dividends) rose 2.1% in sterling terms over Q3, benefitting from a weaker pound. The FTSE 100 fell -2.7% over the quarter including dividends and emerging market equities (MSCI EM Index) fell 3.8%. Global bond yields rose steadily over the quarter leading to higher quality bonds (as measured by the Bloomberg Global Aggregate Index) falling 3.8% (bond yields and prices move in opposite directions). Lower quality ‘high yield’ bonds also fell, down 1.9% as investors worried about the strength of the global economy. After strong gains earlier in the year, oil fell 23.4% over Q3 whilst gold fell 8.1%.
Data source: Financial Express
Indices used (including interest & dividends): Defensive Investment Grade Bonds – GBP hedged Bloomberg Global Aggregate Index; Riskier Bonds (High Yield) – GBP hedged Bloomberg Global High Yield Index, Developed World Equities – MSCI World Index in GBP; Emerging Market Equities – MSCI Emerging Markets Index in GBP; FTSE 100 (UK Large Capitalisation Equities)
Diving into stylistic performance within indices, high price’ securities (often described as ‘growth’) bounced back somewhat over the quarter, up 3.3% as did smaller companies, up 3.1%. Cheaper ‘value’ companies (which generally includes oil & gas and other commodity companies) relatively underperformed over the quarter, rising just 0.9%.
Data source: Financial Express
Indices used (including interest & dividends): Developed World Equities – MSCI World Index in GBP; Growth Equities – MSCI The World Growth Index; Value Equities – MSCI World Value Index; Small Company Equities – MSCI World Small Cap Index
In terms of currencies, the pound had a weak quarter overall. It fell 8.3% against the US dollar, 2.0% against the euro and 2.2% against the yen.
The PortfolioMetrix Core portfolios fell over the quarter, but less than the FTSE All Share. Lower risk portfolios sold off slightly more than higher risk portfolios given their lower dollar exposure (higher risk portfolios hold more equities than lower risk portfolios and many of these companies are either priced in US dollars or earn dollars as part of their operations). Asset allocation was mixed with a small relative underweight to outperforming US equities being unhelpful, but lack of exposure to dramatically underperforming UK bonds supportive in lower risk portfolios. Active fund performance was broadly neutral over the quarter. UK funds underperformed given overweights to poorly performing UK small and mid-sized companies, but this was offset by strong active returns in other asset classes.
Sustainable World portfolios performed more or less in-line with Core portfolios overall, having bounced harder earlier in the quarter, before later retracting their outperformance. We do believe sustainable funds continue to enjoy significant long-term structural drivers as the world shifts to focus more on environmental and social issues (for more on this, please see our blog on the topic: Portfoliometrix – Long-term-case-for-sustainable-investing.
Moving into the last quarter of 2022, there is still really only one question driving markets: “when will inflation definitively begin to fall?”.
Source: Deloitte COVID-19 Economics Monitor, 29 September 2022
And the reason this is so important is that it links directly into when central banks will be able to ease up on their aggressive tightening. Having been raising rates throughout Q3, markets are currently pricing in significant further moves, for example to just under 6% in the UK next year (the Bank of England’s UK base rate is currently 2.25%).
Source: J.P. Morgan Asset Management Guide to the Markets UK Q4 2022
And why central bank rates are so important for markets is that these are reflected in the current prices of all investments in some way. They show up directly in lower bond prices (higher expectations for future central bank rates cause bonds to fall) but also indirectly in equity prices (lower bond prices increase the relative attractiveness of bonds to investors who then sell equities to buy those bonds causing equity prices to fall). If inflation starts falling, then central banks may be able to raise rates less than currently expected. This would cause bond prices to rise and, possibly with a lag, equities to start performing better too.
Whilst nobody knows for certain, economists currently predict that the US is already past its peak inflation level. They predict peak inflation should be reached in the UK and the Eurozone in Q4 (at just over 10% CPI for the UK) before falling back in all three regions to close to central bank targets of 2% by the end of 2023.
Source: J.P. Morgan Asset Management Guide to the Markets UK Q4 2022
Now, economists and markets have over the last year been hopelessly behind the curve in terms of anticipating actual inflation, so it’s quite likely that inflation doesn’t decrease as quickly as expected. However, there are good reasons to believe that we are indeed past or near the peak. Many post-COVID bottlenecks in the form of shipping rates, lorry drivers or new car production (as a substitute for used cars whose prices spiked as economies re-opened) have been cleared. Energy prices remain elevated, particularly in Europe, but would need to keep increasing from here to continue to contribute to higher inflation, which is more difficult from these already elevated levels.
Source: J.P. Morgan Asset Management Guide to the Markets EU Q4 2022
And should energy prices fall from here, they would start to contribute negatively to inflation. From an energy store perspective, Europe is now actually in quite a good place with its gas inventories near 90% full. At these inventory levels, it would then take a particularly cold winter (as well as limited wind to power the continents’ wind farms) to strain supplies.
Source: J.P. Morgan Asset Management Guide to the Markets UK Q4 2022
The other likely driver of lower inflation is a slowing global economy. Growth expectations have already fallen significantly and it’s likely that the US, UK and Eurozone will all experience technical recessions. These need not be particularly deep recessions though – not all recessions are as serious as that sparked by the global financial crisis. A shallow recession wouldn’t necessarily cause deeper asset price falls than we’ve already seen.
That said, the speed of rate rises by central banks risks is exposing vulnerabilities within the financial system that had previously been hidden by the era of lower interest rates. We’ve already seen one example of this in the UK where falling bond prices coupled with derivative positions in the pensions industry saw dramatic swings in the normally placid government bond market, before the Bank of England stepped in to stabilise prices. Expect volatility ahead as markets await signs that inflation is indeed falling and whether there are any other market fracture points out there.
Whilst economic uncertainty is high, the indisputable silver-lining is that most asset prices are now pricing in a lot of bad news and are now good value. Equities are cheap in most areas outside the US, and even in the US are slightly below long-term average valuations.
Source: J.P. Morgan Asset Management Guide to the Markets Q4 2022
And bonds, after their falls this year, now have far more generous yields than they began 2022 with, implying much greater return potential going forward (remember, bonds are already pricing in aggressive future rate rises – which means they can perform well as central banks continue to tighten monetary policy just as long as they don’t hike more than already expected).
Source: J.P. Morgan Asset Management Guide to the Markets Q4 2022
Given the relatively more attractive valuations, we are optimistic for the long-term returns of portfolios, although we do continue to favour diversification to manage what is likely to be a bumpy ride over the near-term.
The third quarter of 2022 saw continued dramatic tightening by a number of developed and emerging market central banks. The US Federal Reserve raised rates by 1.5% and accelerated quantitative tightening (letting some of the bonds they bought during COVID mature without reinvesting the proceeds), whilst the Bank of England tightened rates by 1%. There were, however, a few notable exceptions. China loosened rates slightly to support its economy, battered by issues in their property market as well as the impacts of its zero-COVID policy. The Russian central bank, which had dramatically raised rates in Q1 to defend its currency post western sanctions, also continued cutting rates in Q3.
GDP figures released in the third quarter were for Q2 2022 and were mixed, with China in particular experiencing a below expectations fall on its COVID lockdowns. The US saw its second quarterly GDP fall in a row, the technical definition of a recession for many countries, although given the strength of its labour market is not yet likely to be declared in recession officially. Inflation generally increased during Q3, although it’s possible that it peaked in the US during the quarter. Unemployment generally fell as economies continued their recovery from COVID.
Note: The above returns are total returns, including dividends and interest payments. Asset classes with the “HDG” label are currency hedged to pounds sterling, which means that foreign currency movements are removed whilst those with the “£” label indicate that we are reporting returns to British holders which includes the effects of the foreign currency moves non-UK listed securities are exposed to.
Data source: Financial Express
Indices used: Bank of England SONIA, GBP hedged version of FTSE World Government Bond Index, GBP hedged version of FTSE WorldBIG Corporate Index, GBP hedged Bloomberg Global High Yield Index, GBP hedged version of FTSE Global Emerging Markets US Dollar Government Bond Index, MSCI North American Index, MSCI Europe ex-UK Index, FTSE All Share Index, MSCI Japan Index, MSCI Pacific ex-Japan Index, MSCI EM Index, FTSE Global Core Infrastructure 50/50 Index, FTSE EPRA NAREIT Global Index and Bloomberg Commodity Index
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Data Source: PortfolioMetrix, Bloomberg
*Glossary of Financial Terms
This document is only for professional financial advisers, their clients, and their prospective clients. The information given here is for information purposes only and is not intended to constitute financial, legal, tax, investment, or other professional advice. It should not be relied upon as such and PortfolioMetrix cannot accept any liability for loss for doing so. Any forecasts, expected future returns or expected future volatilities are not guaranteed and should not be relied upon. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future performance. Portfolio holdings and asset allocation can change at any time without notice. PortfolioMetrix Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. Full calculation methodology available on request.
Home Linkedin Facebook Youtube Instagram Envelope Table of Contents In Brief Q1 2023 was generally positive for global markets Economic
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Consilium Asset Management are Independent Financial Advisors (IFA) based in Bristol and are authorised and regulated by the Financial Conduct Authority. More information can be found on the Financial Services Register under Number 469507. Registered Office: Vayre House, Hatters Lane, Chipping Sodbury, Bristol, BS37 6AA.