Stronger data questions the soft-landing narrative and raises the spectre of "no landing"
The mood in markets has improved dramatically since October as inflation readings softened, China reopened, energy prices fell sharply and labour markets remained robust, allowing equities to rally on the soft-landing narrative. However, markets were due for a pullback following recent strength. The stronger data in January questioned this outlook, leading to speculation of a potential new "no landing" scenario, where growth remains strong despite central bank efforts to engineer a slowdown.
A pullback after January's exuberance, with the UK a notable exception
After a surge in January, the broad-based rally enjoyed by markets since October finally paused for breath. Global equities retraced 2% of recent gains, led by a 6% decline in emerging markets following their recent exuberance over the reopening of China. The rally in global technology stocks also ran out of steam. In contrast, UK equities continued to make progress, closing 2% higher, with the large-cap index recording a new high above 8,000.
Gold also made a new high in sterling terms before succumbing to profit-taking along with other commodities. Bonds retraced recent gains, with UK gilts and corporate bonds down 4% and 2% respectively.
Recession, what recession?
The US economy continued to confound economists calling for a recession. Recent data painted a picture of a far more robust environment in 2023 than expected, with employment growth, retail sales, pending home sales and service-sector activity all accelerating in January. On top of this, the pace of decline in inflation was proving sticky. The January CPI only dropped to 6.4% versus expectations of 6.2%. As a result, bond markets finally capitulated to the more hawkish view of the US Fed that interest rates would have to stay higher for longer.
Elsewhere, China was providing a further boost to global growth, with data confirming a strong rebound following the easing of Covid restrictions. Chinese manufacturing posted its biggest jump in more than a decade.
Retail sales defy the gloom, but inflation remains in double digits
Even the UK economy was faring better than expected. UK retail sales came in above expectations, with growth in January at odds with gloom over the cost-of-living crisis. House prices continued to weaken, however, as the higher cost of mortgage repayments started to bite. Inflation came in slightly lower than expected but remained in double-digit territory at 10.1%.
Brexit returned to the headlines, as the UK's fifth Prime Minister since the referendum reached a new agreement with the EU that aimed to make the compromise over Northern Ireland's trading arrangements more workable. There were strong hopes that the Windsor Framework would finally provide a solution to this impasse and pave the way for warmer relations in future.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
The path back to 2% will not be quick or easy
The general view remained that inflation had peaked and this would ultimately lead to a peak in rates at some point during the year. Recent stronger data pushed the timing of this further out, along with the hope of any cut in rates soon after. To be fair the US Fed had been consistent in its message of higher for longer. But markets seized on earlier comments that the "disinflation process has begun" to anticipate an early end to hikes and were now having to adjust accordingly. Higher growth comes with the risk of higher inflation, suggesting that the path back to central bank targets of 2% would not be quick or easy.
Investment trends do not last forever, and the moves in both directions tend to be exaggerated by herd mentality.
The UK may also be coming back into vogue. UK stocks have been shunned globally and trade at a discount to their international peers across sectors. Citi recently flagged that the overall UK index was at a record 40% discount to the US on a forward price-to-earnings basis. At least some of this discount occurred due to the uncertainty created by Brexit, a factor that may now be starting to fade. Another key issue has been the sector composition of the UK index, which missed out on the prior strong gains in glamorous technology stocks that drove performance in other major markets.
The lesson of the past year is that investment trends do not last forever. Once a trend has reached an extreme level, it ultimately triggers a behavioural reaction that causes it to reverse. The leadership trend of high-flying technology stocks finally peaked last year at an extremely elevated level. This has paved the way for a rotation in favour of more traditional sectors that dominate the UK market, such as resource giants, traditional bank stocks and consumer staple multinationals, where earnings are rising and valuations remain attractive with strong yield support.
There remains a solid case for investing in commodities as a uniquely good hedge against the stronger growth, higher inflation scenario. Our focus continues to favour value in the UK and other under-owned markets.
Commodities as an inflation hedge
There remains a solid case for investing in commodities as a uniquely good hedge against the stronger growth, higher inflation scenario. This sector, along with infrastructure and gold, remains an effective diversifier across our standard portfolios while such macroeconomic uncertainties prevail.
The UK at a record discount
UK stocks have been shunned globally and trade at a record 40% discount to the US on a forward price-to-earnings basis. The sector composition of the UK index, dominated by resource giants, banks and consumer staple multinationals, is well positioned for the current rotation away from technology leadership.
Value and equity income
More traditional sectors that dominate the UK market offer rising earnings, attractive valuations and strong yield support. This rotation in leadership away from technology is likely to continue, underlining our focus on both value and equity income.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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