1st November 2023
Stockmarkets continued to readjust to the likeliness that interest rates are predicted to stay higher for longer but there is great expectation now that interest rates seemed to have peaked. There was plenty for investors to focus on with the war and escalation in Gaza, bond yields reaching historic highs and a deluge of data announcements.
Whilst the War in Ukraine is still taking place, the general news flow and especially in relation to stockmarkets had abated. The attack by Hamas on 7th October and the escalation since then has caused market jitters. Stocks do not like uncertainty, and this is especially the case when we have an economic environment which already has negative pressures, such as the likes of inflation and higher interest rates, which are providing difficulties. The concern is whether this conflict stays confined to a face-off between Hamas and Israel or evolves into a more extensive regional conflict that includes Iran’s proxy militant factions, particularly Hezbollah, which could carry substantial consequences. The latter could lead to higher oil prices, mainly due to worries about supply and therefore prolonging a higher inflation environment. Our Investment Committee are keeping our fingers on the pulse and monitoring the situation.
Withstanding the conflict in Gaza, the global inflation picture is still broadly falling. Eurozone inflation fell more than expected to 2.9% and this reflected falling energy prices and a drop in food prices. Economists expected the figure to come in at 3.1% so this was welcome news. UK shop price inflation also fell to its lowest level in more than a year. As we lead up to the Christmas period, these lower prices may boost household incomes and spending which will be a vital boost for the UK economy. Finally, US core inflation, which is considered as an important inflation metric, also continued to fall. The outlook for inflation, without a large geopolitical shock, is on a downward trend and this looks likely to continue into 2024.
The spike in inflation is what has caused central banks to increase interest rates to try and dampen price rises and this is now feeding into the global economy. The consequence of this is higher borrowing costs for individuals and corporates and this naturally is a headwind for stockmarkets. However, there are still many companies out there which are showing economic resilience and are continuing to grow even in these difficult conditions. Whilst it has been a difficult year, we have still been pleased that we have weighted our portfolios in areas which have provided relative outperformance to our benchmarks.
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 over a 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 offset some 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 potential to 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 and the region is 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 high proportion 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 so are 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 continued upwards trend in US equities is the narrowest in history, with just a select few large tech companies carrying the entire index higher. We do not expect this to continue in perpetuity.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 31st October 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.
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