This October/November 2023 market update is brought to you by LGT Wealth Management

Softer economic data, muted price pressures and a weaker labour market buoyed equity markets in November, with the rally continuing into December.

Following the exceptionally strong GDP growth in the third quarter, the softer economic data was a welcome respite and gave market participants further confidence that not only is the rate hiking cycle over, but that central banks may have managed to successfully engineer a soft landing.

This sent the S&P 500 up 9% in November, rising a further 3% by mid-December. Small capitalisation stocks, that have performed poorly for most of this year, saw substantial gains in excess of bellwether indices.

Earlier this month, Job Openings and Labour Turnover Survey (JOLTS) data came in lower than expected in October, indicating businesses were less keen to take on more staff. Job openings fell to the lowest level in two-and-a-half years [1].

While the JOLTS report showed labour market conditions loosening, nonfarm payrolls indicated the labour market remains tight, as the unemployment rate unexpectedly declined to 3.7%.

The consumer price index (CPI) data meanwhile showed price pressures moderating to 3.1% on an annualised basis. More encouragingly, on a three month basis, CPI came in at 2.2%, although core inflation remains higher at 4%. However, after stripping out the shelter component, inflation is 2.1% year-over-year.

While all three major central banks kept rates steady, US Federal Reserve (Fed) Chairman Jerome Powell did surprise market participants with a so-called ‘dovish pivot’.

The median expectation from the Fed is now for three rate cuts in 2024. By the end of 2024, the Fed now envisage rates being 0.50% lower than the third quarter of this year. This would take interest rates to 4.5% by the end of next year.

Futures markets had already moved ahead of the Fed, pricing in 1% to 1.25% of rate cuts before the meeting. The change in language buoyed this momentum, with 1.5% of rate cuts now priced in. This pushed ten-year Treasury yields back to 4% for the first time since July [2]. This benefitted corporate bonds as investors reassessed default risk on the back of lower rates.

While the Fed pivoted, both the Bank of England (BoE) and the European Central Bank (ECB) remained more sanguine.

The BoE has the longest uphill battle when it comes to reaching its inflation target, and ideally would like to see wages come down before it considers any rate cuts.

The ECB meanwhile is more constructive on their growth outlook relative to the consensus. However, there is no question the Fed wields an enormous amount of influence as it still seen as the world’s central bank. This means the BoE and ECB’s messaging often falls on deaf ears.

The Bank of Japan added to volatility over the month with initial reports they may look to abolish negative interest rates at their next December meeting. These expectations of abandoning negative interest rates have since been watered down.

We believe the juggling act between growth and inflation will be more prevalent in 2024, making our preference for investing in quality businesses that compound earnings over the cycle even more important to portfolios next year.

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. US resilience versus elsewhere has seen the Dollar remain supported. The ‘dovish pivot’ from the Fed has seen the Dollar lose some momentum. Weakening growth dynamics in the UK and Eurozone has brought forward expectations of rate cuts in coming quarters. The interplay between growth, rate expectations and inflation combined with upcoming elections is likely to drive gyrations between the main currency pairs over the coming year.

Fixed Income

With peak rates firmly in sight and the debate shifting towards the timing and extent of rate cuts, this has seen bonds rally sharply from the October peaks. With inflation concerns fading, this has buoyed sovereign bonds. On balance, the levels of conventional and inflation-linked rates are still elevated relative to history. However, the supply picture combined with quantitative tightening programmes may keep volatility elevated. As such, we still believe a neutral stance is appropriate.

As central banks have normalised policy, we have seen bond yields across the board move higher. With the BoE, ECB and the Fed unwinding their balance sheets, this is taking liquidity out of the market. While the yields on offer are elevated relative to history, investors have moved to take advantage and have been heavily favouring corporate debt. As such, the additional compensation for corporate bonds in light of moderating economic momentum has become less attractive. We would therefore advocate a highly selective approach.

As financial conditions tighten further, there is typically 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 amidst the historically moderate compensation for this asset class.

Emerging Market Debt 

With developed market central banks adopting a tight monetary policy stance, this historically has weighed on emerging markets. While many emerging market central banks have already raised rates substantially, which is likely to result in a much smaller impact than previous hiking cycles, certain countries are facing debt sustainability issues. Therefore, we retain our neutral stance across this diverse asset class

Equities 

The volatility in Sterling amidst the hiking cycle and economic prospects has driven large swings in the components of the FTSE 100 index. 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. 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 moderating inflation pressures have supported European stocks from a low base. However, the issues surrounding longer-term energy security remain and political challenges, such as the gains secured by populist parties in the Netherlands and Italy may weigh on future growth potential. Furthermore, the ECB’s aggressive hiking cycle may exacerbate the 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, while technology stocks have led the market on the back of AI optimism. Furthermore, the outlook in the face of rising interest costs and slowing demand may be more challenging for earnings going forward. Hence, we expect volatility to continue. Nonetheless, the US market remains a source of attractive companies with good long-term prospects.

While the Bank of Japan’s new Governor has delivered a moderate tweak to policy, the shift that many investors had been expecting has not yet materialised. The Yen remains weak due to this confused messaging. However, given the export nature of the Japanese economy, this has supported the Nikkei Index at least in local currency terms. Given moderate valuations and increased international investor interest, Japan could have room to perform if global growth remains resilient.

China’s rebound from its re-opening 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 increasing stimulative policies bear fruit. The risk of political business interference in China remains high but is cushioned by the cheap valuations relative to other markets. A growing China tends to provide support for the wider region. The lack of sanctions on Russia confirms 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.

While some emerging markets are being impacted by softening goods demand from the West, their policy mix has seen inflation rates remain more moderate, offering them more scope to stimulate domestic demand. However, tightening financial conditions in the West may reduce investment in foreign economies and could weigh on sentiment. Despite this, long-term growth prospects for many emerging markets remain high. Hence, 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 (M&A) activity. Conversely, the elevated levels of interest rate volatility may present opportunities elsewhere. On the regulatory side, geopolitical shifts 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 these strategies. Nevertheless, 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 are likely to further dampen enthusiasm for long-term assets with limited liquidity. This could see lockups in open-ended property funds become more commonplace. Therefore, 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.

[1] US Bureau of Labour Statistics

[2] Bloomberg