It was a rollercoaster quarter for markets, which finished with both equities and bonds making positive returns, with UK equities (as proxied by the FTSE All Share total return) closing up by 3% and UK bonds (as proxied by the FTSE Actuaries UK Conventional Gilts All Stocks Total Return Index) closing up by 2%.
2023 started with a January rally for equities and positive fixed interest markets. This was down to slowing inflation and the prospect of interest rates peaking, together with re-opening in China after strict COVID restrictions. In February, equity and fixed income markets were weighed down by strong economic data and “sticky” core inflation data which raised the prospect of even tighter monetary policy and a longer road to peak interest rates. In March, the collapse of SVB and Signature Bank in the US and the fire sale of Credit Suisse to UBS hit financial sector shares in the US and Europe hard and caused a general pullback in equity markets. However, government bonds rallied as a “safe haven” asset.
Our investment outlook for 2023 (link here) was called “turning the corner”, with the key thrust being that the stock market is forward looking and not reflective of the economy as we live and breathe it today. This was very much evident in the first quarter of 2023, with stock markets that posted handsome returns in the midst of some pretty miserable economic data. This was a quarter which saw UK inflation remain in double digits, anaemic levels of economic growth, simmering tensions between the US and China and the failure of 3 banks – one of these being a major global one.
The fact that investment markets posted such positive numbers speaks to their forward-looking nature. Yes, the newsflow was fairly miserable (reflective of the “cost of living” crisis), but – and here’s the important thing for stock markets – it was less miserable than expected. This triggered a push higher in stock markets.
In terms of the winners and losers, European share markets saw the best gains over the quarter (with that market up close to 9% in GBP terms), whilst Emerging market equities were the laggards (up c0.8% in GBP terms). Digging beneath the surface and looking at it from a sector basis, it was the technology and consumer discretionary sectors which fared best, with the energy and banking sectors (very unsurprisingly so for the latter) lagging. The big names in technology and consumer discretionary reaped the benefits of having made widescale cuts to their workforce in the back end of last year and early this year, with the mercenary stock market rewarding the ruthlessness of having more efficient company structures and leaner workforces.
It would be remiss to conclude on the outlook for equities without a mention of the recent turmoil in the banking sector as well as a comment on valuations and earnings. Sadly, instances like that which we saw at SVB, and Credit Suisse are prone to occur when interest rates rise. The abrupt rise we’ve seen in interest rates (to their highest level since 2008) puts pressure on the financial system and causes the weak to falter. Rather than dwell on the financial feedback loop, we feel this process is perfectly captured by a quote from superstar investor Warren Buffet, who opines that “only when the tide goes out do you learn who has been swimming naked”. The banks that went under in Q1 (sticking with Mr Buffet’s metaphor) were certainly under-dressed if not fully naked! Without wishing to downplay the short-term angst that this caused the stock market, we’d note the strong performance of the acquiring banks and also a strong corporate reporting season from the banking sector at large which has seen an uptick in deposits amongst the larger banks and a stabilisation in deposits amongst smaller banks. It is early days in the broader Q1 earnings season, but we’d note that results have been generally better than expected and that equity valuations (outside of the US market) are broadly attractive.
Bond markets also posted decent gains in the first quarter, but again, it was a rocky ride for investors. On balance though, the quarter ended with yields lower than that which they started (with UK 10-year bond yields closing out the quarter with a yield of 3.5%) and credit spreads slightly tighter (which boosts returns of these investments). The key question that the bond markets are asking is around interest rates and whether we have seen the peak in interest rate rises. Our view is that the pain here is very much in. We’d expect perhaps 2 more interest rate increases from the Bank of England (which is priced into the market) and would then expect to see interest rate cuts as we head into next year.
As we push through May and the summer, we’d expect to see inflation begin to fall back although still remain at fairly elevated levels. This, combined with attractive valuations in these assets, tends us towards focussing on companies that pay healthy dividends and have good visibility on their earnings. Blending these sorts of equity investments with shorter dated fixed income (with yields north of 5%) is, in our view, the best way to preserve and grow wealth in these choppy and uncertain times.
The value of investments and the income from them can go down as well as up and you could get back less than you invested. Past performance is not a reliable indicator of future performance.
The content of this article should not be relied upon when making investment decisions, and at no point should the information be treated as specific advice. The article has no regard for the particular investment objectives, financial situation or needs of any specific client, person, or entity.
