This June/July 2023 market update is brought to you by LGT Wealth Management

Global equity markets were generally positive over June, as the narrow rally in equities finally started to broaden out to other sectors.

That said, technology stocks continue to lead the rally, with the FANG+ index reaching a new all-time high in July, passing its previous peak from November 2021.

Government bonds came under pressure in June as central banks reasserted their hawkish stance, however in July bonds rallied on growing hopes of a soft landing as price pressures moderated.

UK

Following higher than expected inflation numbers in June, the Bank of England (BoE) sought to re-establish its inflation credibility by increasing the increment of rate hikes at the June meeting to 0.5% from 0.25%. This pushed rates up from 4.5% to 5%.

The BoE continues to warn of further hikes if inflation persistence continues.

The transmission of monetary policy appears to have been blunted given the change in the dynamics of the housing market and mortgage financing. However, this latest move has seen mortgage rates reach their highest level in 15 years, with growing concerns around overtightening and thus risking a potential policy error.

US

Turning to the Federal Reserve (Fed), after having opted not to raise rates at the June meeting, US CPI data for June came in below expectations on both headline and core.

Headline inflation rose 0.2% month-on-month, taking the annual rate down to 3%.

The core data also rose 0.2% month-on-month, but the annual rate remains at an elevated 4.8%.

The labour market continues to complicate the inflationary picture. While nonfarm payroll growth came in weaker for June, wage growth is still elevated.

The Fed has been consistent in its messaging that it wants to see service price pressures moderate further as these are most influenced by the labour market. So, the market is pricing in for the Federal Reserve (Fed) to raise rates by 0.25% at the July meeting.

However, this may be the last hike, especially given a broader moderation of goods prices and slowing economic momentum.

Europe

Having signalled further rate hikes at the June meeting, the European Central Bank (ECB) looks near certain to hike at the July meeting.

While headline Eurozone inflation has shown signs of moderating, core inflation has been quite sticky. As such, the ECB has struck a hawkish tone, guiding towards a possible rate hike in September and signalling that any rate cuts are some way off.

The picture is further complicated by recent political developments with the riots seen in France and the resignation of the Dutch Prime Minister.

Polling data for right-wing parties across Europe has shown signs of increased discontent with the establishment and risks more populist policies over the medium term.

As the Eurozone has been in a technical recession, further rate increases could pile additional pressure on growth and cause further political fragmentation.

Asia

Given that the bounceback in growth in China has so far disappointed following its reopening, there appears to be pressure building for additional stimulus from policymakers.

Investors are looking towards an expected Politburo meeting in July for an indication of any policy direction.

While policy loosening in China continues to be at odds with policy tightening in the West, given the deflationary trends seen there, this appears to warrant more concrete action. With the Chinese stock market trading on very weak sentiment, any marginal good news would likely be very well-received by the market.

In contrast, Japanese equities have seen strong support in the second quarter of this year. They have been supported by robust economic data and a sharp weakening of the Yen.

On a dollar basis, Japanese equities have broadly traded in line with their global peers.

Overall, Western central banks are getting closer to the end of their hiking cycle, but each are at different stages in the battle against inflation. There is a growing belief that the Fed may have navigated the economy on a path towards a soft landing.

However, the effect of prior rate increases is expected to have profound economic effects over the coming quarters. So, the challenge will be tweaking policy to ensure the balance between growth and price pressure stabilisation, without compromising on both.

For this reason, we continue to advocate for a selective approach of quality companies that can display long-term compounding of earnings.

Market View Changes

• No changes

Currencies

The US dollar remains the reserve currency of the world and continues to benefit from its safe haven status. The growing belief of a soft landing has seen the dollar weaken.

The level of rates and growth resilience so far has seen the euro and pound bounce sharply from their October lows. However, should the challenges presented in the Eurozone and UK economy lead to a harder landing, this may see the “greenback” supported yet again.

Fixed Income

Government bonds have gyrated materially as investors sought to understand the reaction function of central banks in the wake of the unfolding banking crisis.

As the economy has proved resilient so far, the sharp rally in March has seen a reversal, but given moderating price pressures, yields are below their highs seen this year.

Given the UK inflation shock in the second quarter, gilts are now yielding in excess of their US peers and offer value.

However, we would continue to stress caution on the long duration nature of index-linked gilts.

With central banks still reducing their balance sheets and given the uncertainty surrounding the inflation outlook, we still believe a neutral stance is appropriate.

As central banks have normalised policy, we have seen both government bond yields and credit spreads move higher. With the BoE, ECB and the Fed unwinding their balance sheets, this is taking liquidity out of the market.

Given the elevated yields on offer, investors have moved to take advantage and have been heavily favouring corporate debt. While yields look attractive relative to history, the additional compensation for corporate bonds has become less attractive.

As such, we would advocate a highly selective approach.

As financial conditions tighten further, this typically results in an increased level of defaults. While companies have extended maturities, resulting in less acute pressures, sentiment may weigh on this market.

The overall yield looks attractive, but we would stress selectivity and likely ongoing volatility.

Emerging Market Debt

With developed market central banks still set to tighten policy somewhat further, this historically has weighed on emerging markets. However, many emerging market central banks have already raised rates substantially, which is likely to result in a much smaller impact than previous hiking cycles.

Yet, certain countries are facing debt sustainability issues. Additionally, recent elections have caused larger swings. We therefore emphasise that selectivity remains as important as ever, and we retain our neutral stance across this diverse asset class.

Equities

While cyclical exposure had buoyed the FTSE 100 Index last year, financials and commodity exposure alongside the strength in Sterling, has seen the index lag peers this year.

The market continues to trade at valuations that look cheap compared to markets elsewhere in the world, which may offer investors the opportunity to pick up companies at discounted prices.

As such, we have seen an uptick in takeover activity. However, the UK domestic economy faces headwinds from inflation and interest rate rises, weighing on more domestic focused stocks such as those in the FTSE 250.

Considering the mix of factors, we recommend a selective approach in this market.

After a torrid time last year given the outbreak of war on its borders, the combination of a less acute energy crisis and the reopening of China has improved the outlook for Europe with luxury stocks benefitting from this.

However, the issues surrounding longer-term energy security remain and political challenges may weigh on future growth potential.

Additionally, the ECB’s aggressive hiking cycle may exacerbate longstanding issues between nations of the Eurozone.

As such, we retain our neutral view.

The ongoing volatility surrounding growth, inflation and its impact on the long-term discount rate has continued to cause gyrations between cyclical and less cyclical companies.

Bank stocks remain weak, whilst technology stocks have led the market on the back of AI optimism.

Additionally, the outlook in the face of rising interest costs and slowing demand may be more challenging for earnings going forward. So, we expect volatility to continue.

Yet, the US market remains a source of attractive companies with good long-term prospects.

The Bank of Japan’s new Governor has stuck to the old script so far.

As the shift that many investors had been expecting has not materialised, this has seen the Yen weaken materially versus its broader peers.

However, given the export nature of the Japanese economy, this has buoyed the Nikkei Index towards its longer-term highs.

Given moderate valuations and increased international investor interest, Japan could have room to perform if global growth remains resilient.

China’s rebound from its reopening has been underwhelming, resulting in recent policy loosening.

While consumption has bounced, weak external demand has weighed on its industrial prowess. The equity markets have given up most of their earlier gains, providing scope for a re-rating should stimulative policies bear fruit.

However, the risks of political business interference in China remains high, but this is cushioned by the cheap valuations relative to other markets.

A growing China tends to provide Market Views, LGT Wealth Management 4/5 support for the wider region.

The lack of sanctions on Russia confirm that energy headwinds are less of an issue for some countries in the region.

As such, we think the potential for long-term growth is higher here than elsewhere.

Emerging markets continue to be caught in the middle between softening goods demand from the West and a Chinese reopening that is yet to gain steam.

Commodity prices have softened from their peaks as supply chain concerns have moderated, but declining export demand continues to weigh on the outlook. Despite a weakening dollar, ongoing geopolitical uncertainties highlight the importance of selectivity.

Additionally, developing countries need continued foreign investment but the outlook, combined with tightening financial conditions in the West, may adversely impact sentiment. Despite this, long-term growth prospects for many emerging markets remain high.

So, we continue to stress a highly selective approach in this diverse universe, emphasise its volatile nature and maintain our neutral stance.

Alternative Investments

Hedge Funds/Targeted Absolute Return

Given pronounced movements across interest rate expectations, this will undoubtedly weigh on financing costs which may temper some merger and acquisition activity.

Conversely, the elevated levels of interest rate volatility may present opportunities elsewhere. On the regulatory side, geopolitical fronts mean that regulatory intervention has become more commonplace.

This has tempered our enthusiasm for event-driven strategies. More broadly, when allocating to this space, we look for funds that could diversify returns away from the directionality of conventional bonds and equity markets, and favour such strategies.

Although, we continue to stress the importance of finding the right vehicle and investment manager, which requires extensive due diligence on the strategy and fund.

Property

Rising borrowing costs continue to weigh on property markets globally.

Tightening liquidity conditions is likely to further dampen enthusiasm for long-term assets with limited liquidity. This could see lockups in open-ended property funds become more commonplace.

So, we continue to stress that any exposure to property should be selective and closed-ended over open-ended vehicles.

Although property has historically been a good hedge against inflation, the sharp rise in borrowing costs may alter that characteristic, at least in the short to medium term.