The second quarter of 2023 saw clear divergence between the Global economy and the UK economy. The Global economy showed sure signs of turning a corner and this was reflected in good returns for global stock markets. Conversely, the backdrop of stubbornly high inflation in the UK had the effect of backing Bank Governor Bailey into a corner, with the resultant higher UK interest rates biting on both UK stocks and bonds. Whilst bad news for UK assets, we’d note that we cast the investment net a lot wider than just the UK and that returns over the quarter were broadly positive.
Cutting to the quick of it, the second quarter saw global stock markets post returns of 3.7% in GBP terms and UK stock markets post returns of -0.6%. From a regional perspective, the clear winners were the US and Japanese stock markets (both up over 5.5% for the quarter), with Emerging market stocks being the clear laggard (down by 2.2%). At a sector level, the heavy lifting was done by the technology and consumer discretionary sectors as excitement about Artificial Intelligence (“AI”) and a resilient US consumer helped to drive markets.
Bond markets were less positive in the second quarter, with UK bonds being hardest hit. The 2nd quarter saw UK government bonds fall by about 5.4%, with UK corporate bonds falling by about 3.3%. These bonds (which tend to be longer-dated in nature) fell in value as yields rose on the back of rising interest rates and persistently high inflation. This was very much a UK specific problem in Q2, as inflation (CPI) fell less than expected to 8.7% which led to the Bank of England raising interest rates for a 13th consecutive time to 5% (which makes for the highest level they’ve been at since October 2008).
What drove the rise in global markets?
For global markets it was a classic case of stocks climbing a “wall of worry”; climbing higher as the contents of the worry list got ticked off. The banking crisis that had threatened at the end of Q1 didn’t materialise (banks are for the most part very well capitalised), corporate earnings came in stronger than expected and inflation came down faster than expected (seemingly everywhere apart from the UK!). In addition to this, the US increased its borrowing limit in early June (making for the 79th time it has been raised, extended or revised since 1960) which set the stage for a strong rally to end the quarter as uncertainty disappeared.
There was much scrutiny on corporate earnings following March’s banking crisis and generally companies held in very well and performed less badly than feared. Encouragingly for stock markets, there was evidence that the big banks had reported fairly good results (in some cases benefiting from picking up customers that left the smaller banks) and that generally, companies had been able to pass along price increases resulting from rising inflation.
Coupled with the better results from corporates came the evidence that inflation was falling back and that interest rate rises would be less severe than once feared. US inflation finished the 2nd quarter running at 4%. Whilst this is still more than the Federal Reserve would like it is over half as high as it was last June when it peaked at 9.1%. Evidence of falling US inflation means that we’re now expecting just one more interest rate hike (to take US rates to 5.5%) from the US Federal Reserve which will help provide further oxygen for stock markets and mark a turning point for bond markets.
Another key driver of global stock markets in the second quarter was the performance of big US technology stocks and, in particular, Nvidia. Nvidia rose by nearly 50% in the 2nd quarter, with the rise largely attributable to increased revenues associated with its AI computing capabilities.
What about the UK?
Persistently high inflation and higher interest rates made it tough going for UK assets. Although it’s not coming through in the prices of stocks and bonds just yet, we’d note that the market reaction suggests that the course being taken is the correct one. Sterling rose by about 3% vs the US Dollar over the quarter (and is now up nearly 20% since the depths of the September “mini-budget”) and the bond market rallied on the day that Andrew Bailey put interest rates up by 0.5%. These movements suggest that the correct medicine is being administered and in the correct dosage.
Food inflation running at close to 20% combined with wage inflation at over 7% makes for sticky inflation. Although painful for the mortgage market, we’d suggest that interest rates of 5% are the right course of action from the Bank of England and expect several more to come over the next few months. This goes a long way to explaining the poor plight of UK bonds in the 2nd quarter of this year, but with a yield of 4.4% (at the end of Q2) we’d note that UK government yields are now reflecting reality and beginning to look very interesting as investments.
Where next?
We’d expect choppiness to remain for both the UK and Global markets as the readjustment to a world of higher interest rates and higher inflation takes shape. Recession seems likely, but the strength of the jobs market and resilience of the US consumer (that matters more for global markets than the UK consumer) suggests that recession should be short-lived. Furthermore, the fact that US inflation has fallen back so much means that the Federal Reserve has room to cut rates should recession bite. We’d continue to highlight that the bad news is very much in the prices of assets and that investment markets are forward looking and will be sniffing out lower inflation and lower interest rates (and rising accordingly) long before we’re seeing it impact our everyday lives.
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.
