1st May 2023
UK inflation remained stubbornly above 10% last month, frustrating the Bank of England and Treasury who forecast price rises to fall below 10% for the first time this year. This makes for a challenging outlook for the economy, where the BoE will need to continue raising interest rates for longer than anticipated in order to bring inflation under control. The higher rates go, and the longer they remain at these levels, the greater the impact on economic activity. Of particular concern is the potential impact on the housing market, where a large number of homeowners see their fixed mortgages end in the coming two years, which could mean millions of people must lock in higher mortgage rates. Inflation does look to be cooling around the world though, so hopefully the outlook is more positive from here.
US economic activity remains firm, with both economic growth and employment remaining strong, along with falling inflation. Though price gains are still higher than the Federal Reserve would like, traders are pricing the Fed to end their hiking cycle after the coming meeting. The recent failure of yet another bank in First Republic Bank marked the second largest bank failure in US history, and demonstrates the stresses imposed on the banking sector as a result of simultaneous interest rate hikes and quantitative tightening (QT). JP Morgan took control of First Republic’s deposits, ensuring liquidity in the system, and averting contagion for now. Given the Fed is set to halt rate hikes after the next meeting, perhaps we have seen the maximum stress on the banking sector in the US, though it remains to be seen whether other small, regional banks come into trouble in the coming months ahead.
2023 has continued the recovery in risk assets following what appears to be thepeak 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 1st May 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.