
2023 – update on the markets so far
Six months into 2023 and market volatility still seems very much the order of the day; but what has caused this market concern and are there signs of this abating?
Stubbornly high inflation is still causing headaches for the Federal Reserve, the European Central Bank and Bank of England.
In the US the Federal Bank has undertaken the fastest rate hike campaign since the 1980s and the markets seem to have finally grasped inflation’s persistence and have given up on the idea of rate cuts in 2023 (markets had previously priced in price cuts before the end of the year). The Federal Reserve has announced they are pausing interest rate increases for now but warned that there could be two further rate increases this year.
The European Central Bank also raised rates in May and announced they aren’t finished yet and more interest rate increases are likely in 2023.
Here in the UK, inflation stuck unexpectedly at 8.7% for May and the Bank of England raised interest rates by a bigger than expected 0.5% to 5.0%. Market expectations for the end of the year are for the UK base rate to be up to 6.25% - the highest level since the late 1990s.
Of much concern is how many homeowners in the UK will see their fixed rate mortgage deals end (which are much cheaper than those available on the market now) and how much of a squeeze this will be on household income. The prevalence of fixed term mortgages produce the effect of delaying the impact of rising interest rates as households still have disposable income and this could force the Bank of England to perhaps push rates higher than they would otherwise have to do.
What does this mean for the Pound?
Despite concerns about a weak UK economy and soaring budget deficit, the pound has continued to gain ground against the US dollar in June however against the Euro this has been more muted. Broadly speaking, Sterling is back to where it was five years ago, however the pound will still buy considerably less than it once did.
Markets are betting that interest rates in the US will start to drop sooner than in the UK – US Consumer Price Inflation has fallen quite sharply since Spring but inflation remains stickier in the UK, as such investors are holding sterling for potentially higher returns.
The strengthening of the pound is great for companies that import a lot of goods for sale in the UK – and likewise for holiday makers who may buy more in currency exchange.
The knock on effect however is that the UK stock market is very much exposed to overseas earnings – more than 75% for the FTSE 100 and c. 50% for the FTSE 250. Some UK listed companies earn most of the revenues in US dollars and have very little to do with the UK economy but benefit from a stronger dollar. Their earnings will be adversely affected by the strengthening of the pound.
How have global equities fared so far this year?
Although the S&P 500 index is up just over 8.5% so far this year, having seen a shock in March following the mini banking crisis, this is being driven by a few large technology firms as they benefit from the AI buzz. In recent weeks, performance has dropped off as the markets price in changes in interest expectations.
The FTSE Developed Europe (ex UK) index has performed well, having recovered from March’s turmoil. The index could be impacted by the news of Germany technically being in recession, but greater concern is over higher interest rates affecting corporate profits due to higher borrowing costs. For this year, our
portfolios’ allocation to Europe has been increased as we believe there is more potential for growth over the UK.
Performance chart from 30th December 2022 to 27th June 2023 showing index performance for the year to date on a bid to bid basis.
Japan has also posted positive returns for the first six months of the year although in recent weeks has seen much of the gains made in early June reversed.
Both the emerging markets and Asia Pacific region (ex Japan) have lost all gains they made in the lead up to mid March although for many of the emerging markets, the weakening Dollar will relieve some national debt stresses.
Looking forward, bouts of volatility are probably the only constant that investors can expect for the rest of 2023. With increasing interest rates, investors believe the probability is that economies are heading towards recession which will have an effect on equity markets. So far, they have remained resilient, with strong labour markets and continued consumer spending but it is doubtful this good news can continue beyond the second half of the year.
What about fixed interest holdings?
For a long time, equities offered a much higher yield than bonds or cash and it’s been a long time since investors have been particularly interested in fixed income investments other than for diversification purposes. Now, the consensus view among investors is that bonds are back and the outlook for various fixed income investments confirm a significant shift in investor sentiment.
Investors have been moving to bonds over 2023 on the promise that last year’s big fall in value is ripe for a reversal. So far that trade has failed to deliver the hoped for returns because the peak interest rates keep being pushed further back (and at a higher level). The feeling is, however, that the longer the underperformance goes on, the better the prospective returns from bonds become.
Although bonds have had a bad year, they are still an integral part of portfolio construction. Different asset classes over and underperform over time and it is important to maintain discipline and investment strategy for the longer term and not react to short term market cycles.
Risk Warnings:
The value of an investment and the income from it could go down as well as up.
All investing is subject to risk, including the possible loss of the money you invest.
Past performance is not a reliable indicator of future results.
Diversification does not ensure a profit or protect against a loss.
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice as at 20th April 2023. You are recommended to seek competent professional advice before taking any action.