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Market Commentary July 2023

As we reach the midpoint of 2023, there are signs that the bearish trend in the stock market might be coming to an end. However, considering the Federal Reserve’s cautionary statements about future interest rate hikes, uncertainty will remain, ensuring volatility.

Global shares gained slightly in the second quarter with the advance led by the US and Japan, whilst UK and emerging market stocks lagged. Occasionally, we identify notable patterns that significantly impact market returns in the short term. Undoubtedly, the Artificial Intelligence (AI) theme has exerted a tremendous influence on market performance over the past three (and even six) months as US technology stocks have enjoyed a remarkable resurgence after the brutal sell-off in 2022. The key concern for us is that market returns over the quarter have been extremely narrow. Just seven companies (Apple, Microsoft, Amazon, Google, Tesla, Meta and Nvidia) have contributed well over two-thirds of the US markets’ return this year. The top two stocks in the S&P 500 (Apple and Microsoft) now represent a combined 14.4% of the American index, the highest weighting for any two companies with data going back to 1980.

Focusing more globally, out of the nearly 3000 companies included in the World Index, 60% experienced negative returns over the quarter, with the average stock delivering a  -2.4% return. The variance between the MSCI World’s total return of 3.3% and the average stock’s return of -2.4% serves as a significant reminder of the difficulties associated with market capitalisation-weighted indices, and the influence just a small pool of large companies can have over the entire index. Apple’s market capitalisation now sits at circa £2.4trillion ($3 trillion) which is – astonishingly – larger than the entire FTSE 100. This narrow market should rightly prompt investors to question whether some of the risers can justify inflated valuations, while at the same time considering whether those who have been left behind offer better prospects.

The Federal Reserve (Fed) raised interest rates by 25 basis points (bps) in May. However, it did not hike rates in June, adopting what economists have termed a “hawkish pause”. Nevertheless, we still expect further rate rises in 2023. Concerns around the US debt ceiling at the beginning of the period were quickly resolved after Congress approved legislation that suspended the debt ceiling in early June.

UK equities fell over the quarter. The large UK-quoted oil, mining and materials groups were the most significant detractors amid broad-based weakness in commodity prices and concerns over the outlook for the Chinese economy. Sterling strength also weighed on these resources sectors, as it did other significant US dollar earners such as consumer staples. The lack of technology in the UK index also meant it lagged in what has been a very technology-focused market rally this year. UK inflation held firm at 8.7%, unchanged from last month. Core inflation hit 7.1%: the highest since 1992. This data caused the Bank of England to surprise markets in late June by raising interest rates by 0.5% as opposed to the expected 0.25%. The stubborn strength of UK inflation has caused a large re-pricing of interest rate expectations. At the beginning of April, the market anticipated a peak in UK rates of around 4.5%. However, by the end of June, the curve suggested a higher peak range of 6% to 6.25%, with some economists even quoting 7%.

Gilts and Index-Linked Gilts continued to fall over the quarter as bond yields rose due to the stubbornly high inflation prints (the price of a 10-year gilt fell circa 7% over the quarter). However, with gilt yields now at their highest level for 10 years, investors – including ourselves – are revisiting this asset class.

The Japanese market hit the highest level in 33 years with the Nikkei reaching to 33,700 yen in June. That has partly been driven by continuous buying from foreign investors since April.

Emerging market (EM) equities delivered a small positive return over the quarter. Tensions between the US and China were a contributing factor behind EM underperformance, as were concerns about China’s anaemic economic recovery. The Indian equity market performed well as a reflection of the strength and potential of the country’s economy.

It was a mixed quarter for bond investors as they came to terms with the idea that rates will not be falling any time soon. But higher yields resulting from the Fed’s rate hikes also mean fixed-income investments are potentially more attractive now than they’ve been in many years, even if the Fed’s not yet done with its inflation fight.

Looking ahead, it’s premature to think that the economy is “in the clear” from recession risks, and we should be prepared for a possible further slowdown in the economy as we move into the second half of 2023. The key for markets will be the intensity of that slowing, because at these valuation levels (particularly in the US), stocks are not pricing in a significant economic slowdown. The global economy has not yet felt the full impact of the Fed’s historically aggressive hike campaign, and while the economies have proved surprisingly resilient so far, we know from history that the impacts of rate hikes can take far longer than most expect to impact economic growth. Despite these threats, multi-asset investors have access to increasingly attractive investment options. The 2010-2021 period of market belief “T.I.N.A”: there is no alternative (to equities) no longer applies. Government bonds yield around 5%, and alternatives like infrastructure and long-lease property offer high cash flows with significant discounts to net asset value, providing appealing risk-return profiles.

It’s important to remember that recessions are normal parts of economic cycles. Markets have experienced them in the past and have always bounced back stronger. This time is no different, and one should not lose sight of the long-term attractions of investing.

Tom Hopkins MCSI, Portfolio Manager

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