Monthly Market Outlook
Looking further afield let’s envision the possibility of a brighter future
May 2023 (Click here to download)
While sky-high inflation continues to plague the UK, elsewhere, things are starting to look up.
Undoubtedly, the global economy has been through it in the early years of this decade. Covid dragged markets down before vaccines and the lifting of lockdown rules pushed them back up. The UK’s ill-fated ‘mini-budget’ sent bond prices plummeting (and yields rocketing). A handful of US bank failures invited uncomfortable flashbacks of the GFC. The UK is still struggling under the weight of the developed world’s highest inflation figures at 10.1% over the year to March. But, elsewhere, the horizon is brightening.
First, it’s important to acknowledge that economic data is backwards-looking, that is, it reflects what happened in the past and is not necessarily a reliable picture of the mechanisms moving markets today. But, with that caveat behind us, the Manager has seen some favourable figures released in the past month or so. But it is helpful to remember, as the Manager considers the downtrodden data it has seen close to home, that investors in the UK market are actually highly diversified because the FTSE 100 itself is. Therefore, taking a global view can give a better indication of where markets might be headed for the rest of the year.
Let’s look at the US: the Manager has been talking a lot lately about inflation and the tightness of the US labour market, and happily recent data shows things are improving; for one, there are fewer job openings, which the Federal Reserve (Fed) will welcome as a sign that the labour market is beginning to move. Issues in the banking sector are likely to slow growth, but do look contained to regional US lenders and associated borrowers, and a bit of economic slowing may actually be useful for policymakers at this stage of the cycle. But the situation had a marked effect on liquidity: while the Fed has spent the last year or so trying to tighten monetary conditions via higher interest rates, the mini-banking crisis set this trend into reverse, with the Fed intervening to ensure any contagion was contained. This is interesting from a market perspective, because it may be the very thing that sent stock markets up in March (an occurrence that seemed highly unlikely mid-month). Central Banks (both the Fed and the European Central Bank) demonstrated they are willing to do what it takes to prop up the economy and not let another 2008 happen. Investors were comforted in the knowledge that Central Banks will step in if need be.
China released strong growth numbers in April – roughly in line with the Chinese Communist Party’s target of around 5%. That’s a good thing for China, obviously, but could also have a positive impact on global growth – and sentiment – when it comes to investment. Elsewhere, bonds were roughly flat in a welcome contrast from the final quarter of last year.
So, what can we extract from this environment of equity gains, rising Chinese growth and falling inflation in most of the world? It’s fair to say things are looking up. The Fed, in particular, will be able to ease off on tightening measures if inflation and the job market keep moving in the right direction. In fact, falling US bond yields may even imply interest rate cuts from this summer. While not an exact science, the direction bond yields take often implies what bond investors expect the Fed to do. Currently, yields say that investors expect the Fed to cut, and keep cutting, in the second half of 2023. But if that does not happen, it is likely markets could get caught off-guard by more aggressive tightening than seems to be priced in. Bond yields would rise again which, in all likelihood, would reverse the beneficial effects the Manager has seen on equities and credit markets this spring.
Chart 1: Historically, equity prices fall when bond yields rise
Equities – Bonds –
If the Fed doesn’t cut rates, then bond yields will most likely go up. This puts downward pressure on equity prices. If the Fed does cut rates, it would be because growth is flagging. It is something the Manager will remain mindful of. Ultimately, things are still out of balance; but at least they are moving in the right direction.
Bond yields represent the return a new investor can expect to receive from owning that bond to maturity, assuming bond payments are met in full. While on paper it sounds like higher yields are a good thing, for investors who already own bonds, rising government bond yields mean weak returns (because if yields rise, prices fall and vice versa). Also, higher bond yields can signal economic trouble ahead: for example, high, lasting inflation, or higher interest rates make it more difficult for individuals to borrow money, or for governments to finance things like infrastructure projects.
“The FTSE 100 bears little resemblance to the UK economy. It is very broadly and globally diversified.”
Head of Investments
The unexpectedly high rate of growth China recorded over the first quarter of 2023 versus one year ago.
Investment View: Why disappointing domestic data doesn’t have to mean losses for investors
in the UK
The compounding effects of the Global Financial Crisis, Brexit and Covid mean the UK currently faces a profound set of economic and social challenges. Luckily, the UK stock market bears little resemblance to the UK economy.
Regular readers of the Manager’s monthly commentaries may have once or twice asked themselves why it spends so much time analysing events abroad, and generally does not spend that much time talking about the UK. After all, Great Britain is no stranger to the headlines: stories about UK competitiveness declining, companies choosing not to list on UK stock exchanges, Brexit-induced lines of lorries backed up at the border with France. The UK seems to be lagging behind its developed-world peers according to the International Monetary Fund’s 2023 projections, and that inability to compete on a global scale is manifesting in an inauspicious mix of stubbornly high inflation and simultaneously weak growth.
From an investment perspective, the cold, hard question is: does it matter?
Putting things in perspective
As a UK-based company servicing clients who are predominantly in Britain, the Manager cares deeply about the UK and those living in it. The economic landscape has not made things easy in recent years, and the unfortunate truth is that with inflation still high and a number of Brexit kinks yet to be ironed out, certain challenges are likely to last. But, while this could equate to risks for certain UK-focused assets, the stock market itself, in particular the FTSE 100, is not very exposed.
The UK stock market is naturally diversified
This is because the FTSE 100, while domiciled in the UK, is a highly international Index. It is full of genuinely global, outward-looking companies – think AstraZeneca, Shell and Unilever – the fortunes of which are not as closely linked to the UK economy as you might think. This is one of the reasons why in some of the down months of 2022, the UK market outperformed developed-market peers, despite the disastrous mini-budget and a potential energy crisis.
. . . and so is the Manager
While there’s no free lunch in investing, making sure you are maximising diversification is critical, and is one of the Manager’s core principles when making asset allocation decisions. It means the Manager’s portfolios have exposure to a wide array of assets and markets, so, it is not overly reliant on any one region or industry. Think of it like this: the UK’s share of the global economy mimics its diminutive geographic size. Generally speaking, the Manager’s portfolios have relatively modest direct exposure to the UK because UK assets are a relatively modest share of the global total. The Manager is invested more heavily in the larger drivers of economic and market outcomes, in particular, the US, Europe and Asia. This is why it spends a lot of time tracking policy and market outcomes in these economies and talking about what is happening there.
Chart 2: UK markets are not necessarily full of UK companies
Having a global outlook is, after all, one of the many things the UK is good at. To maximise clients’ financial well-being, diversifying amid many different countries is the best approach; tracking and managing portfolios requires a truly global eye.
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