Our latest Investment Strategy Quarterly provides informed insights into a turbulent market with analysis on economic situations at both home and abroad, the questions facing policymakers and investors, plus reasons to be optimistic in the long term. Read all this and more in Investment Strategy Quarterly: Time is on Our Side.
One of the implications of the banking woes has been for the markets to price in lower terminal interest rates and interest rate cuts towards the back end of 2023. This has been supportive for sectors such as technology, which tend to command higher valuations in a lower interest-rate environment. The tech-heavy US Nasdaq 100 index fell over 30% in 2022, but has seen a very strong rebound, rising nearly 2% this week and around 17% for the first quarter. This is in complete contrast to the energy and banking sectors, which enjoyed very strong rises last year, but have fallen in 2023.
It was a quiet week in terms of economic data, with most of the news flow centred around the UK and Europe. Inflation data from the Eurozone showed the year-on-year inflation rate fall to 6.9%, lower than expected and lower than last month’s figure of 8.5%. The European Central Bank (ECB) is likely breathing a sigh of relief to see inflation continue to fall. Central banks in general are caught between a rock and a hard place, trying to bring down inflation without toppling over the economy. This lower-than-expected inflation data may allow the ECB to ease up on future rate hikes. Staying with Europe, German employment data showed the unemployment rate in Europe’s biggest economy nudged up from 5.5% to 5.6%.
There was mixed data from the UK. Finalised Q4 GDP data showed the economy grew 0.1% in the final quarter, having previously been reported at 0% growth. The data meant that the UK economy grew 0.6% for 2022, which is considered below-trend growth. House price data highlighted that higher interest rates are now impacting home values. Nationwide house price data showed prices had declined by 3.1% over the last 12 months. House prices have been expected to fall given that the sharp rise in interest rates has driven up the cost of mortgage debt servicing. The impact will be a negative wealth effect and could be detrimental for consumer confidence and spending.
Richard Hughes, chair of the Office for Budget Responsibility shared his views on Brexit, saying it had a big detrimental impact to the UK economy, estimated to be around 4% of economic output. However, there was some positive news for the UK economy by the end of the week with reports that PM Sunak was close to agreeing a trade-deal with the Pacific bloc.
While the first quarter of 2023 may not have felt that positive, portfolio returns have been pleasing. From a portfolio construction standpoint, its’s been welcome to see equities and bonds behave differently in recent weeks, something that did not occur last year. The reversal in equity market leadership in 2023 is a reminder of why we try and stayed balanced and diversified across equity style and region.
Andy Triggs, Head of Investments
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
One of the surprising elements of the deal was that holders of Credit Suisse AT1 bonds have effectively been wiped out, while shareholders were not. CS had issued approximately $17bn of AT1 bonds and rumours are circulating that bondholders are preparing a lawsuit against the Swiss regulator.
Following on from the emergency takeover of CS, all eyes were on central banks this week, who were due to meet and set interest policy. The concerns around the banking sector were not enough to deter central banks from raising interest rates further. The US Fed and UK’s Bank of England both raised rates by 0.25%, but struck a cautionary tone, acknowledging that higher rates are impacting the economy. At this moment central bankers are walking a tightrope, trying to bring down inflation through higher interest rates, while not causing financial instability.
UK inflation data, released on Wednesday, provided an unpleasant surprise, coming in at 10.4%, against an expectation of 9.9%. The uptick in inflation (previous month 10.1%) was driven by food and non-alcoholic drink prices, which rose at the fastest pace in 45 years.
The big winners this week were defensive assets, with government bonds and gold performing strongly. Bonds rallied (yields fell) on the expectation of lower future interest rates. The gold price has passed through $2,000 per oz this week. The precious metal is often viewed as a safe-haven asset and the price of gold does well when real yields fall – something we have witnessed this week.
Equity markets have been mixed this week, with UK and European equities struggling for momentum by the end of the week. It’s pleasing that the inverse correlation between bonds and equities has returned recently, something that was missing in 2022.
It was banks, a strong sector in 2022, that was bearing the brunt of the pain on Friday, a sign that central banks measures to calm markets may not yet be sufficient. Another strong performer in 2022, the energy sector, has also been weak of late; the oil price has fallen on the back of a more uncertain economic outlook which has fed through to underlying share prices.
The strong relative performance of Apple and Microsoft in recent weeks, the two largest companies in the US, has seen their combined weight reach 13.3% of the S&P 500 – the highest level on record. That means for every $100 invested into the S&P 500, $13.30 goes into just two companies. Within the global equity index, Apple now has a bigger weight than the whole of the UK market!
This week may end up being remembered for two major events; the demise of Credit Suisse, and potentially the end of the interest rate hiking cycle, with the real possibility the US Fed (and Bank of England) may well pause, before potentially cutting rates later in 2023.
Andy Triggs, Head of Investments
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
US inflation data saw another fall as the inflation rate dropped to 6% (year-on-year) for February and core inflation (excluding food and energy prices) dropped to 5.5% matching expectations. This data point strengthens the consensus that we have seen the peak in inflation and the US Fed interest rate hikes are having their desired effect. Although US Fed Chair Jerome Powell is insistent on staying the course until inflation reaches the 2%, the SVB debacle and vulnerability of the nation’s banking system may change the Fed’s approach. Last week investors were almost certain the Fed would be raising interest rates by another 50bps, however the banking concerns could now lead the Fed to a lower increase, or even pause interest rate hikes.
The demise of Credit Suisse has been a gloomy one to watch as Switzerland’s second largest bank has battled multiple scandals since 2021. These scandals have led to consecutive losses reported and the stock market value has nosedived almost 90% from $91 billion to around $8.8 billion. Switzerland’s central bank has recently lent the bank up to $54 billion in an attempt to shore up liquidity and begin to restore investor confidence. The famous Savoy hotel located in Zurich has also been put up for sale to help raise additional capital.
On Thursday, the European Central bank raised interest rates by 50bps, a strong hike despite the thoughts of investors that policymakers would hold back on rate rises until the turbulence in the banking sector eases. However, ECB president Christine Lagarde has stuck to her fight against inflation stating that “the banking sector is currently in a much stronger position than where it was in 2008”. Also, she has set out a new framing for the ECB’s decision process that will consider financial data as well as economic data in order to gauge the impact higher interest rates were having on the economy. Despite raising interest rates, the market has lowered its expectation on the peak interest rate level in Europe from 4% to 3.25% on the back of this week’s banking issues.
Turning our attention to the UK, on Wednesday the Chancellor Jeremy Hunt delivered the UK Budget. His first bold claim was that the UK would be avoiding a technical recession this year. The budget was certainly meaty with several key measures unveiled; the easing of costly childcare costs, the continuation of the energy price guarantee for the next three months, a freeze on fuel duty, the follow through with the raised corporation tax to 25%, and a pension tax shake up with the aim to ease the UK’s workforce squeeze. Figures for the UK unemployment rate were released on Tuesday at 3.7%, staying the same as the previous month, however job vacancies continue to fall for the eighth month in a row. The UK has been stricken by public sector strikes with workers mainly protesting over pay failing to keep up with the rise in inflationVolatility returned to markets this week, with large swings in both equities and bonds. Sectors such as financials and energy, which had been the star performers in 2022 suffered the most. UK equities fell considerably on Wednesday, with the large-cap index suffering one of its worst days since 2020. Some of the strongest performing funds this week in portfolios were some of the laggards from last year. This strengthens our consistent message on the need for diversification in portfolios. It is impossible to predict the future however, history has shown us that during these uncertain moments opportunities are created for investors with a long-term horizon.
Nathan Amaning, Investment Analyst
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
Our Spring Budget Newsletter breaks down the Chancellor’s recent announcement, outlining what it means for you and helping you to plan for the new tax year – which is almost upon us.
One of the most anticipated events this week was the commentary of US Fed Chair Jerome Powell on Tuesday. It’s important to remember that commentary from Powell can often be as significant as the actual interest rate moves as it signals to investors the trajectory of future rates. The main takeaways were that interest rates were likely to rise more than expected in a response to strong inflation and economic data, and the Fed are prepared to move in larger strides, possibly returning to raising rates by 50 basis points. The Fed’s base rate is 4.75% following February’s 0.25% rise, but investors are now predicting rates could rise to 5.6% at its peak. The S&P 500 dropped around 1.3% on the day with the 2-year treasury yield rising to 5% for the first time since 2006.
UK Chancellor Jeremy Hunt is also set to speak soon as investors brace for next week’s budget. With a £30bn windfall in the public sector borrowing, Mr Hunt is facing more pressure to relax the harsh stance he took when first entering the job. He is expected to lay out economic growth measures, address Britain’s workforce and announce tax incentives even with corporation tax climbing from 19% to 25% next month. It is possible to assume that Mr Hunt may be unadventurous with this March budget to leave himself and the Conservative party wiggle room, as he eyes the election timetable.
The UK has certainly been hit with a cold snap this week which is adding strain on the country’s power and transport networks. The national grid was forced to use coal reserves on Tuesday but has not been exerted for the extra supply on any other days.
Germany, Europe’s largest economy, makes the weekly again as they have without warning vetoed their European Union deal to effectively ban the sale of new cars with combustion engines from 2035. The EU have bid to cut emissions by 55% by 2030 with car pollution accounting for almost 30% of worldwide pollution. Germany’s automotive industry is approx. 5% of the country’s GDP, with carmakers Mercedes Benz, Volkswagen and BMW employing over 800,000 people. It looks like Germany will now not support the proposal without a clear plan on how synthetic fuels could be used to meet the zero-CO2 target.
US bank Silicon Valley Bank (SVB) saw its share price collapse on Thursday and is down heavily in pre-market trading this morning. The bank has seen a run-on deposits and as such has had to sell bonds for liquidity, locking in heavy losses. The bank has a high reliance on venture capital corporates as clients, who are now being advised to withdraw their deposits which is escalating the problem further. The concerns around SVB’s survival has impacted banking shares in general, with the sector down on Friday morning. HSBC share’s were down around 5% at open.
US Non-Farm Payrolls data, like last month, came in ahead of consensus. The data showed 311,000 jobs had been added to the economy, against an expected increase of 205,000. Wage inflation was 0.2%, lower than last month’s 0.3% and the slowest increase since February 2022.
This was always going to be an eventful week, with key speeches and data releases occurring, and markets have also had to digest the unexpected events unfolding at Silicon Valley Bank. Next week looks equally as busy, with all eyes on the US Fed’s meeting and to what degree they will raise interest rates further.
Nathan Amaning, Investment Analyst
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
Before we discuss the likely reasons for the market movements in February, it is worth considering investment timeframes, and the perils of being too short term. Writing these monthly pieces is a reminder to me about the difficulties with investing and why it is important to take a long-term perspective. It feels like each month there is a new story for investors to focus on and a change in market direction and leadership. If we were to follow the short-term noise we would continually be buying at recent highs and selling at recent lows. The two very different market conditions in January and February this year are evidence of this in action. Often the world is not as bad, or indeed not as good as the short-term noise suggests, and for those long-term investors, willing to look through the noise, there can be significant long-term rewards. It is always worth remembering the quote from Warren Buffett – “The stock market is a device for transferring money from the impatient to the patient”.
And so, to February. The optimism of January, driven by expectations of falling inflation and a stronger-than-expected economy, made way to a view of inflation re-accelerating and central banks being forced to take interest rates higher, and keep them there for longer. The “Goldilocks” narrative of January was soon replaced with the “higher for longer” narrative for February.
US Inflation data came in at 6.4% (year-on-year). This was ahead of expectations (which were 6.2%) and only slightly lower than the previous month’s 6.5%, indicating the pace of change was slowing. This data challenged the view that inflation was on a clear path lower and called into question whether the US Fed could ease up on their fight against inflation. We witnessed a rise in bond yields (fall in price) as investors priced in higher US interest rates later this year. As was the case last year, higher expected interest rates negatively impacted equities, with some of the bond proxy stocks being hit hardest.
European inflation data, released at the end of the month, confirmed that the battle against inflation may not yet be over. Surprising jumps in both French and Spanish inflation data led investors to price in a higher terminal rate for European interest rates (moving from 3.5% to 4%). Higher interest rates, kryptonite for bonds, led to rising government bond yields (falling prices). The yield on the 10-year German bund hit 2.70%, the highest since 2011. Less than a year ago the same 10-year bund had a negative yield!
During the month of February economic data releases broadly came in ahead of expectations, indicating that the US and global economies were more resilient than expected. Again, this helped to feed the new narrative that the work of central banks may not yet be over, and a period of higher rates for longer may now be upon us. US Non-Farm Payrolls data, one of the most watched data releases, highlighted extreme strength in the labour market. The previous six months had seen a slowing pace in job hiring in the US and this was expected to continue into January. The consensus view was for around 185,000 jobs to be added to the economy. The official number was above 500,000! This strong hiring in January points towards tightness in the labour market, which is likely to continue to put upward pressure on wage inflation. Here in the UK the labour market also remains tight, while wage inflation has recently been exceeding expectations. After the Bank of England raised interest rates by 0.5% at their previous meeting, they are now expected to carry on further and increase rates by an additional 0.25% at their next meeting (taking rates to 4.25%).
In the previous monthly piece, we commented on some of the drivers of the stronger-than-expected economy and these factors are likely to have continued to support the economy in February. As a reminder, these were plummeting gas prices in Europe and more generally cheaper energy prices globally, and the re-opening of China and rebound in economic activity currently underway in the world’s second largest economy.
The swing in sentiment in February generally led most asset classes lower, in complete contrast to January when almost all assets rose in value. As has been highlighted already the oscillating nature of markets in the short-term can lead one to overtrade and continually chase their tail in search of returns. We think the probability of success, or at least repeated success, is extremely low from taking such short-term views.
We are taking note of the recent data, but as the saying goes, one swallow does not make a summer. Our bigger-picture thinking still leads us to be cautious about the global economic outlook. We are mindful that it will take time for the impact of higher interest rates to feed through to the economy. Remember 12 months ago the US Fed hadn’t even begun to raise interest rates!
With higher expected returns on defensive assets, such as cash and short-dated government bonds, we believe we are being paid to be patient, a scenario we have not really experienced over the previous decade.
Appendix
5-year performance chart
Risk warning: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. Past performance is not a reliable indicator of future results. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.
Andy Triggs
Head of Investments, Raymond James, Barbican
Continuing with our weekly review rather than a history lesson, UK home owners have had their own battles with house prices. It is important to remember that house prices soared during the pandemic, boosted by ultra-low interest rates, stamp duty tax incentives and greater demand for living space, but we are now seeing a reverse. Average house price growth turned negative over the month of February, with the 1.1% (year-on-year) drop being the first annual decline since the pandemic. In the current climate of high inflation and rising interest rates, home owners that have attempted to sell their property have on average had to shave approximately £14,000 off their asking price. The “cooling” effect on the housing market is likely to continue as potential home buyers will be facing higher mortgage rates as the Bank of England (BoE) are predicted to further raise the base rate by 25bps at the next meeting.
The housing market in the US has been estimated to fall by 4.5% over 2023, this is modestly lower than previously expected despite the prediction that interest rates will continue to rise. The fall is only marginal in comparison to the gains since 2020 – with house prices up a staggering 45%.
Tesla is seemingly in a world of trouble again after their strong start to the year. The share price took a plunge in 2022 due to a plethora of concerns: Mr Musk’s Twitter takeover, halts on production at China factories, and fears on the demand for electric vehicles (EV’s). However, after a tough 2022, performance has since soared as Tesla has delivered 75% year to date. Their highly anticipated investor day was on Wednesday as Mr Musk and other executives detailed plans to cut manufacturing costs and invest in a new plant in Mexico. The 7% fall in share price on Thursday was triggered by the lack of detail when the top executives were pushed on a timeline for on a new model, expected to be affordable and accessible for households.
European Central Bank (ECB) Chief Economist Phil Lane made major comments this week as he gave some insight into the thoughts of the key policymakers. He maintained that the ECB would not end rate hikes until they were confident inflation was heading towards the 2% target with rates raising by 300bps since July 2022. However, he believes that monetary policy is filtering its way through the economy, with lower oil and gas prices, the easing of bottlenecks and China’s reopening as factors that will help lower inflation. Markets are now expecting rates to continue to increase to 4% by the end of the year.
China’s reopening from their strict zero-Covid policy continues to be positive as manufacturing activity expanded on Wednesday at its fastest pace in over a decade. PMI (purchasing managers index), which is an index of the direction of economic growth in the manufacturing sector, shot up to 52.6 from 50.1 in January. The PMI impressively beat the forecast of 50.5 and is the greatest expansion since April 2012. The news positively impacted Asian equities, feeding into markets as the Nikkei 225 closed 1.56% up on the week and the Hang Sang closed up 0.68%.
The roundup of the weekly is always consistent even if this isn’t always the case with markets. We continue to blend asset classes in portfolios to diversify risk(s) and smooth the overall return profile.
Nathan Amaning, Investment Analyst
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
In this month’s Market Commentary, Raymond James UK European Strategist, Jeremy Batstone-Carr, discusses a new term in the financial lexicon, a change in the market’s tone and why, despite the challenges ahead, there is cause for optimism in the long run.
This week the Chancellor of the Exchequer was handed a timely boost with the UK running an unexpected budget surplus in January. With the budget set to be delivered on the 14th of March, the surplus of £5.42bn ideally gives Mr Hunt some wiggle room to potentially fund short term tax cuts or raise spending. However, he has set a stern tone this week stating that there is no possibility of greater pay for nurses and public sector workers despite the ongoing strikes.
New Rolls Royce CEO, Mr Tufan Erginbilgic’s term has got off to a flying start with the company beating profit forecasts. They are hoping for more consistent performance this year as underperformance in previous years was heavily influenced by the pandemic; grounded aircraft led to a significant collapse in revenue. They have estimated that this year they will return to 80% – 90% of pre-pandemic engine demand.
German inflation has shown little signs of easing as high food and energy prices persist. The year-on-year figure for January was 8.7%, coming in higher than December ‘22. Germany have certainly felt the brunt of the Russia/Ukraine war as households saw a 23.1% energy rise on the year despite significant government relief measures. The high inflation in Europe’s largest economy may influence the European Central Bank’s interest rate setting policy.
Strong early US market performance has begun to unwind as investors mull the US Fed’s next move. Bonds and equities have once again been positively correlated in recent weeks, with equities falling as bond yields rise (prices fall). A series of strong economic data readings have led investors to price in higher interest rates and a delay in a potential ‘Fed pivot’. The S&P 500 is down -2.49% on the week with its greatest fall in 2023 coming on Tuesday at -2% but is still 4.13% up year to date.
We have seen another historic data release this week as Japan inflation hit a 41 year high in January, core inflation rising 4.2% year on year. The Bank of Japan will soon have a new man in the hot seat, Mr Kazuo Ueda, and he faces a decision on whether to abandon the current ultra-low interest rate policy. He spoke this week stating the recent acceleration in inflation was driven by rising raw import costs rather than strong demand. Japan’s economy narrowly avoided a technical recession in Q4 of last year but certainly rebounded less than expected as business investment slumped.
As ever we will continue to do the hard work and consider a wide range of asset classes to reduce portfolio volatility and capture investment opportunities. Diversification in asset class, style and management is key in order to navigate the markets. By not losing in the short term, you can win in the long run.
Nathan Amaning, Investment Analyst
Risk warning: With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.