World markets summary:
May was a month of significantly divergent returns, with the Nasdaq 100, Japanese equities and Taiwanese equities up mid-to-high single digits, whilst Hong Kong equities and the oil price fell by similar magnitudes. UK and US Government bonds suffered falls in the mid-single digits, whilst UK and French equities endured similar declines. The US dollar was strong against peers during the period.
However, over the course of the month, investors were faced with several issues to deal with.
Firstly, there was the usual cliff edge wrangling over an extension of the US debt ceiling. As usual, this was resolved, but only at the very end of the month. Next came a slew of underwhelming economic releases from China, causing angst among those expecting a smooth acceleration of activity post COVID-19. In addition, there was evidence of stickier than expected inflation, especially in the UK but also somewhat in the US. Lastly, there was the furore over the investment case for companies involved in Artificial Intelligence (AI). This caused the involved names’ share prices to rise significantly amidst a generally risk-off environment.
It should be noted that last year during periods where interest rates rose, the US generally lagged behind Europe and the UK, and equities classed as “Growth” (for example technology and health care) generally lagged behind equities labelled as “Value” (for example, bank and energy companies). However, last month, the opposite was true as the number of stocks participating in the market rally narrowed near to historically low levels, especially in the US.
If history is anything to go by, then this will be resolved by an increased number of stocks participating as markets advance, or by the overall market declining and current leaders being dragged down.
For a sustained rally to take place, investors need to be convinced an end to interest rate rises is close. We expect this should be forthcoming by the end of the summer. In the interim, we stand ready to take advantage of the volatility that is likely.
Our in-depth views on:
Our weightings are based on sterling as a base currency.
United Kingdom (UK)
Last year, UK shares on the whole performed relatively well in months when interest rates were rising. However, last month was a different story as the UK lost money and was a relatively poor performer compared to peers. Mid-capitalisation shares slightly outperformed large-capitalisation shares in another deviation from the pattern of 2022.
Currently, investors fear that sticky inflation will force the Bank of England to persist with interest rate rises, which will increase the chance of a recession eventually occurring.
A slowdown in Chinese growth following the first quarter of 2023 has also weighed on sentiment towards energy and mining companies, which are well represented in UK large-capitalisation indices, which also explains some of the poor performance seen.
UK shares continued to see significant outflows, more so than peers, as a generally risk-averse mood prevailed among investors.
Our biggest concern is that the Bank of England, which admits it has a credibility issue, keeps reacting to whatever the latest economic data release suggests about the economy and ends up raising interest rates too high and inflicting unnecessary strain on economic activity. In our analysis, it would be better if the Bank paused and let the full impact of the most severe series of interest rises in 50 years work through the system.
At the company level, most managements we meet are already braced for challenging times and we have seen profits generally come in better than downbeat expectations. Ultimately, this should lead to a re-rating (a change in price) upwards of UK shares from valuation levels that are depressed relative to history. As shareholders, we can collect attractive dividends whilst we wait.
United States (US)
Divergence in US equity markets was stark in May. Major small-capitalisation and industrial indices declined, the S&P 500 managed to produce a modest gain but it was the Nasdaq 100 that stole the show, climbing nearly 8%. A euphoric boom in AI-related stock prices has fuelled the technology-heavy index so far this year, one which reached new heights in May following ‘jaw-dropping’ guidance from Nvidia. The semiconductor chip maker increased revenue forecasts for the second quarter of 2023 to levels 50% ahead of analyst expectations, briefly making Nvidia the sixth public company in the world valued at more than $1 trillion. Others on that list include Microsoft, Alphabet, Amazon and Apple, all of which can, in some way, lay claim to being beneficiaries of the AI-mania gripping markets this year. Apple has now reached a valuation 5% greater than the market capitalisation of the UK FTSE 100. With just over a fifth of sales and a third of profits of the index, this highlights both the undervaluation of the UK market and the extremes seen at the top end of the US market.
Elsewhere, the US debt ceiling debate finally approached a resolution. The saga drew headlines throughout the month and markets reacted to such. At one point, a US Treasury bond due to mature early this month (June) yielded more than 7%, as fears of a debt default heightened. With some risks fading as a deal is worked through, bond markets have turned their attention to economic data that has generally been more robust than it was in April. A further rate hike due this month is now seen as very much in the balance.
The old adage ‘sell in May and go away’ certainly held true for European equities as markets gave up some of the gains made earlier in the year, following a deterioration in economic data. This was most pronounced on the manufacturing side of the economy with weak industrial production and construction output figures published. Germany bore the brunt of the industry decline as 2023’s first quarter Gross Domestic Product (GDP) numbers showed a fall in output, highlighted further by monthly declines in retail sales, exports and factory orders. All of which came in well below consensus expectations.
Optimism over the European economy harboured earlier in the year has waned. A warm winter dismissed fears that a recession would be brought on by an energy crisis. However, a further interest rate hike at the beginning of May was accompanied by suggestions that monetary tightening would continue have once again raised concerns of a slowdown. This has been reflected in sentiment across the region as several surveys showed investor and business confidence weakening significantly in May.
Despite the disappointing data, German markets were the best of a bad bunch in Europe in May, falling less than 2%, although broader European markets were down around 3%. German bund yields fluctuated, declining early in the month before climbing, only to fall back again to end virtually flat compared to the end of June 2022 as markets battled with slowing growth and rising interest rates.
Asia and Emerging Markets
The slowdown in Chinese economic activity and corresponding decline in Hong Kong share prices grabbed most of the headlines during May but, elsewhere in Asia, there were some decent advances. Even with regards to China, the more domestically-focussed Shanghai Index fell by less than half the amount Hong Kong did.
Japan was the star of the show, where shares hit 30-year highs as the Bank of Japan retained their policy of capping interest rates and investors poured money in. Vietnam and India also rose whilst the large weighting of semiconductor stocks in their indices boosted both Korea and Taiwan.
We remain optimistic towards Asia as we expect China to ultimately deliver around 5% on GDP growth this year. This should enable profit growth to recommence with share prices following suit.
It should be noted that Chinese households did not receive the furlough payments or direct handouts that were common in the West so the rebound in consumption will not be as spectacular as the one enjoyed in the UK and US. Furthermore, most commentators have long anticipated that the post COVID-19 recovery will be led by consumer, green energy and digital spending, not by massive infrastructure and construction projects as in prior cycles. This will probably mean the recovery is slower but longer-lasting.
Interest rate rises continued in the West during May and UK Government bond (gilt) yields were further hit by an unexpected acceleration in core inflation and consumer confidence hitting a 15-month high. Both inflation and economic activity data in Europe were generally weak, so German bund yields actually fell marginally over the month. Chinese bond yields also edged down amidst a slew of economic releases which pointed to a deceleration in the post COVID-19 recovery.
High yield outperformed investment grade bonds as the asset class benefited from shorter duration and more resilient economies.
There is clearly some confusion among Central Bankers about what to do in the coming months. If they were to look solely at inflation compared to their own expectations of where they think it should be, then further interest rate rises are the correct course of action. However, if one looks at the slowdown in housing and construction sectors and allows for the fact the majority of the impact from past rate rises has still to be felt, then refraining from further rate increases is sensible. Although this is before we consider the impact from tighter lending standards in the US, which have been given further momentum by the collapse of several regional banks.
Markets have changed their minds of late and now expect at least one more hike this cycle in the UK and US.
May was a tough month for oil prices, dropping over 10% after the poor start was met with an equally disappointing finale. The weakness at the start of the month was primarily driven by the Federal Reserve raising interest rates by a further 0.25%, increasing the chances of tipping the US into recession and lowering prospects for oil demand. Meanwhile, the end of the month was greeted with fears over the now-resolved US debt ceiling negotiations and a 4.5 million barrel increase in inventories, with consensus expecting a 1.4 million barrel inventory decline. Looking ahead, on the demand side, investors will be paying close attention to China’s purchasing managers index (PMI) in the hope for a change in narrative to the so far underwhelming recovery. Whilst on the supply side, eyes will be on the Organisation of the Petroleum Exporting Countries (OPEC+) to see whether further production cuts lie ahead in response to waning demand. June is likely to be a stronger month for oil, given the low base, signs of a possible improvement in Chinese PMI, and the clear intent of OPEC+ to support oil prices in a scenario of weak global demand.
Gold was once again flat over the month, seemingly unable to break through the resistance level of $2,000. We remain positive on the outlook, with a likely weakening in the US dollar, lower real interest rates and increasing geopolitical tensions namely between the US and China.
The rise in UK house prices witnessed in April appears to have been a minor correction in a broadly downward trend. According to Nationwide1, house prices registered the sharpest decline since July 2009, falling 3.4% in May year-on-year. Prices also fell 0.1% on a monthly basis, above market consensus of a 0.5% drop, but below April’s 0.4% rise. Excluding the blip in April, prices have now fallen for nine consecutive months. This price weakness continues to stem from the inflation induced squeeze on household incomes working in tandem with increasing mortgage rates. Inflation remaining stickier than expected is likely to cause further rate hikes from the Bank of England. This will act to make mortgage rates increasingly unappealing and lead to a further deterioration of house prices in the future.
1 Nationwide House Price Index, 31 May 2023
All Index data figures are sourced by Morningstar and correct as at 31 May 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.