3rd October 2023
Interest rates were held in the month of September with central banks choosing to hold rates whilst they wait for further inflation data. Whilst this gave some respite to mortgage holders, Stockmarkets saw this as the potential for interest rates to stay higher for longer. This hurt the outlook for some corporates who had to price in higher borrowing costs going forward. The Bank of England’s decision to hold rates also took some by surprise with rates expected to increase to 5.5%. However, welcome inflation data came in which was lower than expected and therefore gave the policy makers headroom to hold fire for one more month at least. Interestingly, revised data from the ONS also showed that the UK had made a stronger recovery from the pandemic than previously expected. This demonstrated a stronger rebound that Germany but in line with France.
In the US, technology stocks took a slight hit based on interest rate expectations. Certainly, amidst all this conjecture, there was a backdrop of uncertainty regarding the number of forthcoming interest rate hikes and the speed at which central banks might reinitiate rate reductions. At the beginning of the year, the market had factored in the possibility of rate cuts occurring in the latter half of the year. However, this concept now seems highly improbable, as the prospect of rate cuts has been shifted significantly to a much later point, likely not until at least the latter part of 2024. This alteration in the timing gained further momentum when the Federal Reserve revised its projection for the Fed Funds rate in 2024, elevating it from 4.6% to 5.1%.
For individuals with over two decades of experience, the idea of swift rate reductions has never been a realistic possibility, particularly in light of the current inflationary conditions. This sentiment is further reinforced by the recent developments in oil prices. Moreover, there’s a prevailing notion that after experiencing near-zero interest rates for an extended period, financial markets were harboring unrealistic hopes that central banks would swiftly intervene whenever challenges arose. This sentiment has grown even stronger since the beginning of the third quarter, despite the fact that some of the more extreme predictions of rate hikes haven’t unfolded as expected. As evidence, the anticipated terminal rate for the Bank of England has decreased from levels well above 6% to its current position at 5.25%.
Interest rates and inflation are still likely to have a big impact on the future of stockmarkets. We are keeping our fingers on the pulse and believe that active management is important as it has ever been.
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 1st 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.