Powell's higher-for-longer message tested investor patience
Global markets continued to drift gently lower in September from highs reached in late July, with equities and bonds both falling by 0.7% in aggregate. The declines in both asset classes were concentrated in the US. In part this was driven by Chair Powell's "higher for longer" message on interest rates, while the political battle over funding the US government also served to highlight the widening budget deficit that has played a secondary role in driving up yields.
Mega-cap technology stocks face regulatory headwinds
The yield on the 10-year US treasury bond increased to 4.8%, a level not seen since 2007. The surge in yields had a negative impact on growth stocks, in particular the mega-cap technology issues, which were vulnerable to a correction following their strong recovery so far this year.
Falls were compounded by negative stock-specific news flow. The US Federal Trade Commission sued Amazon for allegedly monopolising online marketplace services, overcharging sellers and stifling competition, underscoring the US government's push to rein in the concentration of corporate power. Other regulatory agencies have also filed antitrust suits against Google and Facebook parent Meta. There was further concern over how a Chinese ban on Apple's iPhone and other foreign-branded devices among government-controlled organisations could affect the industry.
The debt ceiling returns, but the economy holds firm
The US debt ceiling battle came to a head once again. Congress passed a "stopgap" bill to avoid a shutdown and fund the government until 17th November, while concerns about fiscal discipline led to an internal power struggle that resulted in Republican Kevin McCarthy becoming the first House Speaker to be ousted from the role.
Despite political uncertainty and the continued march upward in interest rates, economic data for August provided fresh evidence of underlying macro resilience. Retail sales and manufacturing PMIs both rose by more than expected. The labour market remained strong: jobs continued to be added at a healthy pace even as vacancies reduced somewhat, and real wage growth held firm. Inflation news was also favourable, with further evidence that momentum is slowing. The Federal Reserve's response was to keep rates on hold but caution against any expectation for a dovish pivot in policy.
Growth revised sharply higher as inflation falls
UK equities were a notably strong performer, rising 3% over the month. Two key positive factors drove the market higher. Fresh figures from the ONS revealed that the UK has bounced back from the pandemic quicker than previously thought and is no longer the worst performer in the G7. In the three months to June, GDP was 1.8% above its pre-pandemic levels. Previously the agency had estimated that GDP was 0.2% below. The revision gives the UK a similar performance to France and a stronger recovery than Germany.
In addition, core inflation fell by more than expected in August to 6.2% from 6.9% the month before. In response, the Bank of England finally stopped raising the base rate, choosing to hold it steady at 5.25% at its latest meeting, ending a run of 14 consecutive hikes that began in December 2021.
Signs of life as stimulus measures start to bite
China's economy showed signs of life as a summer travel boom and a hefty stimulus push boosted consumer spending and factory output. Retail sales growth and industrial production both jumped in August from a year earlier, exceeding expectations. The improvement came as the government continued to beef up pro-growth measures in recent weeks, with further stimulus from the central bank to boost bank lending capacity. These measures should help growth to rebound following evidence that China's post-Covid recovery had been losing momentum since an initial recovery in the first quarter. Chinese equities were unchanged on the month.
Crude oil prices have recovered strongly since the beginning of summer, rising from $70 in June to $90 at the end of September on forecasts by OPEC that output cuts from Saudi Arabia and Russia will tighten the market in the months ahead. This has occurred at a time when stockpiles at the US Strategic Petroleum Reserve have fallen to historically low levels, highlighting a widening global deficit. Meanwhile, demand has remained stronger than expected in Western economies and is now starting to recover in China, a major consumer forecast to account for a significant 75% of the total global increase in demand for 2023.
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
A seasonal set-up for a year-end rally
Financial markets have corrected back to support from overbought conditions in July, following what has been a typical pattern of summer weakness. However, the broader uptrend has remained intact, and markets are now reaching oversold levels that have typically coincided with a low. This provides the potential set-up for a seasonal rally during the final trading quarter of the year. Last October we took advantage of a similar buying opportunity, after which markets enjoyed a strong rally in the first half of 2023. At the time of writing, the sudden escalation of conflict in the Middle East may provide a similar seasonal entry point this year.
Inflation and rising rates have been the key themes in markets these past 18 months. More recently, as inflation has begun to recede, attention has shifted to the potential for interest rates to peak but remain "higher for longer". We may be moving into a phase where investors are able to catch their breath and adjust to a world where interest rates are levelling out, or even easing a little, rather than rising relentlessly. This would allow investors to once again focus on the value that has arisen following several turbulent years.
We may be moving into a phase where investors can catch their breath and adjust to a world where rates are levelling out rather than rising relentlessly.
The UK remains at the largest discount globally. This valuation anomaly in part reflects the misplaced belief that the UK is both a growth and inflation outlier relative to the rest of the continent. Recent data, such as the revision to post-pandemic growth by the ONS, is starting to dispel this notion. The UK is also closing the gap in inflation: German inflation is now higher than in the UK. These statistics reveal that there is not much that is obviously different about the UK that would account for its current discount in valuation terms.
We continue to build portfolios around regions where valuations are attractive and the potential for recovery is greatest, with gold and commodities providing diversification and a hedge against persistent inflation.
Japan: compelling value and improving fundamentals
The Japanese market offers compelling value alongside the UK. Ongoing reforms in the corporate sector are improving profitability, with a positive impact on both earnings growth and shareholder returns via higher dividends and share buybacks. This is in addition to support from the macroeconomic backdrop, where following years of deflation, the prospect of wage growth boosting consumption is providing a further potential tailwind for growth in the years ahead. The Japanese index has reached its highest level since the stock market bubble burst in 1990.
Hedging the yen, and a fund switch
The returns of our holdings in the Schroder Tokyo and Jupiter Japan Income funds have received a significant boost from our decision to own share classes that hedge the underlying yen exposure back into sterling. The yen is now extremely undervalued thanks to the wide differential in interest rates when compared with the US. However, with inflation in Japan running above 3%, pressure is mounting on the Bank of Japan to let rates rise, at which point the yen could surge. We have therefore switched back into local currency share classes ahead of any such move.
New additions to Japan holdings
The existing holding in Schroder Tokyo has been retained as our preferred core holding for standard portfolios. However, the Jupiter Japan Income fund has been switched into the Morant Wright Nippon Yield fund, which has greater exposure to value stocks along with a higher yield. An additional holding in the M&G Japan Smaller Companies fund has also been added on higher risk portfolios.
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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