World Markets Summary:
It was the third tough month in a row for financial assets in October 2023 as investors reacted negatively to stronger US economic growth, “higher for longer” talk from central bankers (regarding interest rates), and the violence in Israel and Gaza.
Bonds, equities, property and commodities all sold off but gold regained its safe haven status and rose sharply during the month. Perhaps the move in gold was exacerbated by the fact that other traditional safe havens such as the US dollar, the Yen and US Government bonds all failed to perform their traditional role, with the Yen and the US Government bonds performing poorly.
Whilst US data was strong, that was not the case in Europe and the UK. Chinese figures started the month strongly but the widely followed Purchasing Managers Indices (PMI) surprisingly weakened when they were published at the end of the period.
Investor angst was reflected by how company profit reports were treated. Not only did profits have to be better than expected (based on their starting valuations), but the makeup of the profits poured over more than usual. For example, a number of US Technology behemoths had to ensure their Cloud numbers were adequate whilst UK banks were treated harshly if their Net Interest Margin and/ or bad debt numbers did not satisfy, even if the overall results and capital positions were fine.
The good news is that November to May is traditionally the strongest period for financial markets. This pattern could be bolstered by the fact that the interest rate hiking cycle is nearly over in the West, if not already so. China started several easing measures two quarters ago and this will work its way through the economy in coming months. An increase in Chinese activity will in turn bolster sentiment in export orientated Europe and Asian neighbours alike.
Risks abound, such as the continuation of quantitative tightening, large volumes of bond issuance to finance historically high government deficits, the evolution of the most widely predicted recession in history. Last but certainly not least, the potential for war spreading to several countries in the Middle East, some of whom are meaningful oil exporters.
However, markets are dynamic and unemotional. The WH Ireland Chief Investment Office (CIO) conducted research on the last two major wars in the Middle East (Iran – Iraq 1980-88 and Iraq – Kuwait & Western Allies 1990-91). In both cases, markets bottomed out within months, not years and strong recoveries ensued thereafter. Whilst a similar outcome cannot be guaranteed this time, it is valuable to have this historical perspective when confronted with sensational headlines.
Equity markets such as the UK and some in Europe and Asia already trade meaningfully below long-term average valuations whilst bond yields are the highest since before the Great Financial Crisis. Even some property funds are now at discounts to Net Asset Value (NAV), which historically have provided profitable entry points. So with volatility comes opportunities and we are taking advantage of these in an incremental way.
Our in-depth views on:
Our weightings are based on sterling as a base currency.
United Kingdom (UK)
Despite a positive start to October, UK Equities ended the month sharply lower with the FTSE 100 shedding 3.69%. The Israel and Palestine conflict elevated oil and gas prices and indicated the possibility that inflation will become harder to tame with interest rates potentially needing to remain higher for longer. The risk-off environment particularly affected mid-capitalisation stocks with the more domestic focused FTSE 250 falling 6.33% to 2023 lows.
The much-anticipated monthly Consumer Price Index (CPI) print showed no change from September with inflation remaining the same at 6.7% vs City forecasts of 6.6%, giving the UK the highest inflation rate amongst the G7 countries. Fierce competition amongst supermarkets lowered grocery prices but these falls were offset by higher petrol and diesel prices. One small positive was that core inflation continued to ease back from 6.2% to 6.1%. As October progressed more positive data detailed that shop price inflation slowed for a fifth consecutive month in 2023 and food inflation eased back further. As we approach the November interest rate meeting the expectations are that rates will continue to be held.
The latest Growth Domestic Product (GDP) release indicated that the UK economy grew 0.2% in August and 0.3% over the past three months in line with expectations. However, generally the UK economic data has continued to show further weakness with the Purchasing Managers Index (PMI) for the services sector declining for a third consecutive month, retail sales volumes for September falling 0.9% and a survey from the Confederation of British Industry showing a significant drop in new factory orders. Mortgage approvals in October hit their lowest level since January 2023 as the impact of rate rises begin to impact this sector.
United States (US)
It was a busy month in the US with several earnings releases, a number of Federal Reserve (Fed) speakers and a slew of economic data releases. Starting with earnings, a number of the tech majors reported with only Microsoft providing comfort to the market. Of the other majors, numbers were not taken well including Amazon and Google missing on Cloud growth and Meta issuing conservative forward guidance. Rising geopolitical risks and 10-year treasury yields hitting 5% for the first time since 2007 also acted as a drag on risk markets. As a result, both the S&P 500 and Nasdaq finished down just over 2% and the Nasdaq has now officially fallen into a correction (i.e. down over 10% peak to trough).
On the Fed speakers, several have implied in recent comments that the sharp rise in long rates might have done the Fed’s work for them and therefore further rate increases are not required. If this is indeed the case, then financial markets may take some relief. Despite this, the majority of market participants are still expecting one more rate rise at the December meeting.
In spite of the sell-off in markets, October once again saw US economic data remaining robust. US GDP, retail sales and industrial production all came in higher than expected. S&P 500 Global Manufacturing and Services also came in stronger than expected late in the month. On housing, existing home sales decreased for the fourth consecutive month while housing starts rose. We are continuing to see that people are reluctant to move home (given US 30-year mortgage rates in the month touched 8% and most people are locked in at around 3%) while those who require new homes are forced into new builds. Several data releases continued to point to a tight labour market, however US consumer sentiment did fall to the lowest level in five months with both a decline in current conditions and in consumer’s future expectations.
In line with the UK and US, the main European markets ticked down a few percentage points in October on the back of some relatively gloomy data releases.
PMI data for October displayed an economy heading further into contractionary territory. GDP data suggested that the economy only grew 0.1% in Q3 2023 after a figure of 0.5% in Q2 2023 and a continuation of this downward trend over the next two quarters would result in a recession. Whilst the wider European economy is flirting with recession, Germany continued to slow and in the process is dragging the rest of Europe down with it. Most notably, inflation in the Euro Area dropped off heavily from 4.3% to 2.9% to mark the lowest figure in over two years. However, core inflation is proving to be sticky and despite the drop-off in headline inflation, it remained unchanged at 4.2%. Nevertheless, the weakening data and downward trending inflation is demonstrating that the rate hikes are working through the economy and as a result, the European Central Bank decided the most prudent action was to sit tight and hold rates steady in October.
At this juncture there are clear reasons to believe we are at or close to the peak interest rate and should inflation continue to fall sharply and the economy fall into recession, a pivot to cutting rates may not be too far off.
Asia and Emerging Markets
Asia and Emerging Markets (EM) were again under pressure in October due to restrictive global liquidity conditions and the US 10-year bond yield reaching the highest level in over a decade. As a result most countries were down low single digits and EM equities continued to see strong outflows in the month. The best of the bunch, although still marginally down were Malaysia and Taiwan.
Up until the last few days of October, Chinese data was again showing signs of improvement with retail sales and industrial production both coming in better than expected. GDP growth also came in better than expected and JP Morgan have now upgraded their Full Year 2023 Chinese GDP forecast to 5.2%. Late in October we did see slightly weaker PMI data in both manufacturing and services. This can be explained by a temporary pause in local government debt issuance and such financing has been bolstered once more.
In Japan, the Bank of Japan (BoJ) left short-term interest rates unchanged but did tweak their Yield Curve Control (YCC) policy by setting the upper bound at 1%. This allows 10-year yields to rise above 1%. This abandonment of YCC has been a call we made earlier in 2023 and we continue to expect a gradual normalisation in the coming months.
In India, we did see a sharp step down in inflation underpinned by the fall in vegetable prices whereas industrial production surged. Valuations remain extreme here with the Nifty close to all-time highs.
Oil traded down nearly double digits over October, but once again, the overall month’s performance did not tell the whole story. Brent Crude Oil surged above $90 after the Hamas attack at the end of the first week of October. However, expectations of a decline in US demand have weighed more heavily on the oil price than the further escalation of the conflict that has been witnessed in recent days. Brent finished the month at $85, which is back below the price when the initial Hamas attack occurred at the start of the month. We are optimistic that the conflict will not become more widespread, but if the oil rich nation of Iran were to get involved, oil prices would once again surge. With global oil inventories recently dropping to 3.21bn barrels, their lowest since the start of 2017, we believe that even in a recessionary scenario oil price risk remains skewed upwards.
In light of the increased geopolitical unrest, investors are seeking safety in assets such as Gold and Bitcoin. Performance for both assets was consequently very strong in October, with gains of 28% and 7% respectively and Gold now sits back at the $2,000 mark. Intuitively, one would expect the opportunity costs of holding a zero-yield asset in a rising real yield environment would drive investors away from these assets. However, given the need for safe haven assets in the continued geopolitical unrest, there is the possibility of a further leg up from here and Bloomberg’s senior commodities strategist believes gold could hit $3,000 next year.
UK house prices unexpectedly rose in October on a monthly basis and the 0.9% increase was the largest since August 2022. This improved the yearly decline from 5.3% to 3.3%, according to Nationwide. High mortgage rates continue to drive mortgage approvals lower, which sit at their lowest since January 2023. However, housing inventory also remains very low and October’s house price rise may be indicative of the fact that supply is even more constrained than demand and provides hope that we are at the end of the property downturn. Mortgage lenders still see more weakness on the demand side, with Zoopla and Lloyds forecasting a 2% and 2.4% house price decline respectively in 2024.
In the US, 30-year mortgage rates hitting a two decade high of 8% has caused existing home sales to plummet to their lowest level since 2010 and ended the surprisingly strong performance of the US homebuilders. Given that the majority of mortgage holders have fixed their mortgages at previously lower rates and these mortgages are non-transferable, existing home sales will likely remain low for the foreseeable future.
As has been the custom these past two years, fixed income investors were subjected to above average volatility during October and returns were once again negative in most part of the market.
Given the events in the Middle East, it is somewhat surprising that US bonds with long maturities (10 years or more) performed so poorly. So poorly, in fact, that the yield on 30-year bonds rose above 5% for the first time since 1998. In troubled geopolitical times, US Government Bonds are usually the safe haven that investors seek. The reason for their underperformance was the continued robust economic growth that was highlighted in several US data releases. This implied there might be a need for further rate increases. Indeed the press release from the Federal Reserve’s (Fed) September 2023 meeting stated that the majority of Fed voting members thought that one further rate rise was necessary. Indeed all of the Fed, the Bank of England and European Central Bank are still delivering the “higher for longer” message on rates although the latter did mellow their language a little after a series of weak European numbers, particularly in Germany. German bond yields went against the trend and fell marginally on the month. Bond yields in the US and UK are not being helped by the unwinding of quantitative easing or the fact that there is huge supply of bonds to finance large budget deficits.
Another big piece of news for bond investors was the decision by the Bank of Japan (BoJ) to effectively cease artificially suppressing bond yields via Yield Curve Control. The BoJ are doing this in a somewhat convoluted way but the ultimate result is likely to be higher bond yields. We have already seen the start of this and bond yields once again moved up in October.
In such a fragile environment, it is no surprise that both the yields and the yield spread required on Emerging Market Debt and High Yield Corporate Debt over safer government bonds increased during October. Both asset classes had hitherto been standout performers in 2023.
We retain the view that inflation will continue to ease over the next year or so and therefore the rate cycle is over, or very close to being so. We are therefore looking taking advantage of the more attractive yields on offer.
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All Index data figures are sourced by Morningstar and correct as at 31 October 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.