World markets summary:
The month was a tough one for financial assets as a series of surprisingly strong economic data releases in the West, coupled with higher than expected inflation readings in Europe and the US, forced investors to reassess how high interest rates would have to go in order to tame inflation.
As we have mentioned in prior commentaries, investors and Central Banks have been sending different messages about how high rates have to go. It now seems, temporarily at least, investors are moving towards the “higher for longer” view of Central Bankers. However, we would caution that the data reflects only one month and that it was a month in which the weather was unseasonably mild thus enabling more economic activity (except ski holidays!).
Oil fell despite Russia cutting output by 500,000 barrels per day and gold touched a two month low during the period as the US dollar and real interest rates rose.
For the time being it looks as if markets will continue to be driven by the level and direction of inflation and therefore interest rates. Despite the January blip we have not seen enough evidence yet to suggest that inflation will be significantly different by year end than the 3.5% to 4% we have been forecasting for some time now.
Consequently we will use further weakness in markets to add to both bond and equity positions.
Our in-depth views on:
Our weightings are based on sterling as a base currency.
United Kingdom (UK)
Both large and mid-cap UK equities eked out gains in the month but small cap stocks gave up some ground, continuing to underperform versus their larger peers.
A point of note in the month was how negatively investors reacted to signs that net interest margins at the big banks were peaking, even if overall results were in line or better than expected. Barclays had the added complication of another fine in its investment bank.
On a more positive note, BAE Systems and, even more so, Rolls Royce performed very well due to the improving outlook in the aviation and military sectors.
The increased likelihood of an agreement with the European Union on Northern Ireland is a positive for all parties and should help the economy at the margin.
Sentiment towards the UK remains low, as evidenced by the International Monetary Fund (IMF) saying it will be the slowest growing G7 economy this year. However, we are more optimistic as we expect both inflation and interest rates to peak by the summer and thus lead to an increase in confidence by year-end.
United States (US)
At the end of the month, US stock markets were down marginally after giving back some of their January gains. The US Federal Reserve meeting minutes, released in the middle of the month, suggested that the US Central Bank would tighten interest rate policy further than previously anticipated. Stronger than expected labour market figures and hotter than forecast inflation numbers did little to dispel these concerns over the course of the month.
On the back of the above, markets behaved much like they had done during similar months in 2022, with bonds and equities selling off in tandem and the US dollar strengthening.
There was also generally more optimism on the strength of the US economy, as several economic activity surveys surprised to the upside. Firstly, services activity moved back into expansionary territory after seven months of decline and secondly, the University of Michigan Consumer Sentiment Index improved to a 13 month high. On the contrary, weakness persisted in the US housing market.
Europe
European markets performed strongly in February versus US peers with continuing improvements in inflation expectations as a result of a third consecutive monthly fall in gas prices and continued elevated gas storage levels. The market is currently highly correlated with the improvements in the gas situation and again the mild weather has helped. Energy prices are still elevated versus historical levels and as a result recession fears remain, however the situation is improving and economic data is holding up better than expected.
To put some of this improving data into context, consumer confidence in the Eurozone again increased with sentiment improving in both Germany and France for the fifth straight month, the Ifo Business Climate Index rose in Germany to an eight month high and the S&P Global Eurozone Service PMI came in much higher than expected. Manufacturing in the Eurozone did however come in slightly softer than in January.
The euro weakened considerably over the month against the US dollar, mainly on US dollar strength as opposed to a weakness in the euro.
We are continuing to see an improvement in inflows into Europe.
Asia and Emerging Markets
It was a month of diverse returns across stock markets, as Japan and Shanghai delivered small positive returns while Hong Kong and Vietnam bourses incurred losses approaching 10%. The latter was impacted by fallout from the government’s crackdown on the property sector. Local market observers are now expecting authorities to switch tack and start supporting this sector, which is an important part of both the economy and the market.
The negative impact of rising bond yields in the West was countered by the strong rebound in economic activity in China following the ending of the zero- COVID policy there. This is exemplified by both Manufacturing and Non-Manufacturing PMI’s rebounding into expansionary territory (i.e. above 50).
As stated in previous commentaries, Asia is much closer to the end of the interest rate raising cycle than the West and has not had as much of an inflationary problem as the West in the first place. These factors mean it is well positioned to fully participate in any global economic recovery, even if the export sector will be caught up in the slowdown in the US and Europe.
Fixed income
Bond yields rose dramatically in Western markets during the month as a slew of strong economic data releases were considered bad for bond prices. Such releases included GfK UK’s Consumer Confidence Index, UK wage growth of 6.7%, UK retail sales volumes, and the UK Composite Purchasing Manager Index’s (PMI) surge to 53 from 48.5 last month (anything above 50 denotes growth and below 50 a contraction in activity). In Europe the strong numbers included German PMI rising above 50 for the first time since last June, whilst the IFO German Business Confidence Index rose to 91.1 from 90.1 the prior month. The US had strong employment numbers, new home sales which were much higher than expected, robust and above consensus Personal Consumption Expenditure and a big jump in the ISM Services PMI to 55.2 from 49.2.
Inflation numbers also came in above expectations in both the US and Europe, although in the UK inflation was lower than anticipated.
Amidst such general economic strength it was therefore no surprise that the Central Banks in Europe and the UK raised interest rates by half a percent and the US by a quarter. European and American central bankers also heavily hinted that investors were continuing to underestimate the need for further rate increases.
Bonds in China and Japan were becalmed in comparison with negligible moves in yields over the period.
Corporate bonds sold off too in February although high yield proved relatively resilient amidst apparent economic strength.
Economic data releases in February refer to January’s data, so an important consideration to note is that January weather was much milder than usual and thus enabled more economic activity than normal, implying recent economic strength is not sustainable. We should also note that manufacturing activity was uniformly weak with the exception of China.
Alternatives
The Gold price declined sharply during February as economic data proved resilient, bond yields continued to rise and the US dollar strengthened. The ‘higher for longer’ interest rate hike outlook as a result of robust economic data is likely to continue to suppress the Gold price and as a result, it may test its floor.
Oil prices were marginally down in February with some signs of rising US crude inventories and ample supply keeping prices subdued. The improved Chinese economic data recently released provides further conviction of a stronger than expected recovery and may support another leg up in the oil price moving forward.
Property
UK house prices recorded their first annual fall in nearly three years in February1. Although house prices have been falling, this is the first time we have seen an annual drop. Annual house price growth fell 1.1% in February compared to the same month last year and the average price of a UK home is now £257,406. Prices fell 0.5% between January and February, the sixth price fall in a row, leaving prices 3.7% below their pre pandemic peak. We expect continuing weakness to come in house prices.
1 Nationwide House Price Index, 28 February 2023
Important Information
All Index data figures are sourced by Morningstar and correct as at 28 February 2023, unless otherwise stated.
The value of investments or any income arising from them may fluctuate and are not guaranteed. Past performance is not necessarily a guide to future performance.