3rd July 2023
Having had a shock inflation figure last month in the UK, expectations were still for a fall, albeit only a small one from 8.7% to 8.4%. The figure released was again 8.7%, as it has become evident that companies in the UK are taking advantage of the situation to increase their margins, much to the understandable frustration of the Bank of England, the government, and consumers. As we discussed last month, it is likely inflation will moderate somewhat in the UK once the effects of the next energy price cap feed into the data (earliest will be August 2023), however the revelation that companies have been increasing their margins will only likely keep inflation higher than anticipated for longer, forcing the BoE to raise rates.
US inflation, meanwhile, moderated to just 4%, and in some states is now close to the Federal Reserve target of 2%. At the same time, economic data has continued to surprise to the upside, proving the US economy more resilient than anticipated and keeping the Fed more hawkish in their communications. The bond market is pricing the end of rate hikes whilst the Fed are communicating that they are likely to raise at least another two times this year.
The European economy has been weaker than the US, with Germany and others entering technical recessions (two quarters of negative GDP), and inflation still high. The ECB has committed to continuing its rate hikes whilst the Eurozone economy is weakening, which can only be a bad combination. With this in mind, European stocks do still represent tremendous value over their American counterparts, albeit with the increased economic risk at present.
2023 has continued the recovery in risk assets following what appears to be the peak of inflationary pressure in the US and Europe, having come under pressure last year from higher inflation rates and recession fears whilst central banks began hiking interest rates. Value equities continue to offer more protection against downside threats compared with their growth peers, as they tend to benefit most from strong recoveries after recession and trade on lower earnings multiples. We are taking a more cautious approach to portfolio positioning for a possible recession. We still like selective growth stocks where there remains true innovation and potential for change, especially recent trends in consumer behaviour that were accelerated by the pandemic but prefer value equities on the whole. We also continue to hold our overall equity weighting at neutral. Fixed income has started looking more attractive following last year’s bear market, with yields now at levels not seen in well overa decade. Bonds also remain an important diversifier in our portfolios. With inflation having seemingly peaked, we believe interest rates could begin to head lower as fears of a global recession pick up. Low duration bonds look the more appealing investment still given the level of inversion in the yield curve, along with selective investment grade credit which was hit hard during 2022. Duration will become appealing again as market participants shift their primary concern away from inflation and towards growth fears, however we are cautious in our positioning here. We also hold an allocation to cash to offsetsome of this fixed income risk and dampen portfolio volatility. We have also been adding ‘alternative’ assets to the portfolios, which offer low-to-negative correlations to traditional asset classes (stocks and bonds) and give the potentialto protect during times of significant market volatility, such as we are seeing at present.
The UK market is very value-tilted and despite this year’s positive relative performance is still highly attractive on a valuation-basis. The UK economy has also recovered well from the pandemic, though economic growth is faltering. The main driver of UK equity outperformance will be relative valuations.
There is good value to be found in European equities, however with war on thecontinent and the ECB lagging significantly in its inflation outlook and response, there are many headwinds on the horizon for the European economy. Despite this, equities in the region are attractive given historic valuation differentials to the US, and financial companies stand to benefit with interest rates on the rise.
The US represents poorer value relative to the rest of the world due to the highproportion of tech companies that still command a multiple far in excess of the broader market, however it also has the best long-term earnings growth and some of the most outstanding quality companies, as well as the most innovative. In times of global stress, the US also tends to act as a safe haven investment, which props up markets. Overall, we are cautious on the US and soare positioned underweight in portfolios. We do believe the US will remain an attractive investment option in the long-term, but with some obvious headwinds making us more cautious for now.
We believe Japan to be an extremely poor environment for equity performance. The Japanese economy is predicted to grow at the slowest pace of all regions, in addition with a declining and ageing population, the prospect of future economic expansion looks unlikely. Thus, we expect poor relative equity performance from Japan. In the short-term, attractive valuations in the region may boost markets, but this will likely be short-lived.
Asia Pacific & Emerging Markets
Asia Pacific and Emerging Markets are predicted to see exceptionally strong GDP growth over the several years and with China’s reopening look set to outperform the broader global equity market. Thus, we are comfortable maintaining an overweight position. The more recent remarks from the Chinese government have been positive but must be taken with a pinch of salt. We currently like frontier markets as a more attractive investment option within the emerging markets universe. Typically, market move in cycles and EM vs US performance is no different. We have been in an extended period of US equity outperformance, and we now expect this trend to change in favour of EM stocks.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 3rd July 2023, and are subject to change.
The content of this publication is for information purposes and should not be treated as a forecast, research, or advice to buy or sell any particular investment or to adopt any investment strategy. It does not provide personal advice based on an assessment of your own circumstances. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness. Any expressions of opinion are subject to change without notice.
Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.