We fully appreciate that your view on financial markets over the pasts few years would probably contain so many expletives it would be unprintable. In fact, it is pointless trying to sugar-coat it: the past couple of years have been rough for both equity and fixed-interest markets. As an example, the FTSE-100 index is currently sitting 7% below its all-time high.
First came the coronavirus outbreak and associated lockdowns; then just as the economy started to reopen came the war in Ukraine, and with it a massive energy and food price shock, resulting in higher inflation and one of the fastest monetary tightening cycles ever.
Unfortunately, this valuation period (5 July 2023 – 5 October 2023) has seen more of the same as both global equities and fixed interest markets declined as inflation and the possibility of further interest rate increases by the world’s major central banks, coupled with China’s slowing economy, has hurt market sentiment: in the US the S&P 500 index lost 4.24% over the three-month period, while in Germany the DAX fell 5.44%, France’s CAC lost 4.28% and Hong Kong’s Hang Seng ended the period 9.92% lower.
However, we may soon be able to start breathing a little easier: whilst financial markets have reacted negatively to higher interest rates, there is no real sign of the kind of downturn we typically experience with higher interest rates. In fact, economic data isn’t indicating we are headed for a severe recession, just a slowdown – the so-called soft-landing (in other words where economic growth is slowed to help reduce inflation without triggering a recession – just like when an aircraft touches the runway in a nice gradual and smooth way).
Furthermore, with inflation readings slowing, the odds of central banks increasing interest rates even higher are not just receding, but we believe that interest rates will be lower this time next year.
Consequently, while cash deposits may be seen as a safe asset with deposit accounts offering 5 or 6%, it should be remembered that the yield you get on cash is typically only valid for one day – and this time next year, the yield obtainable on cash balances is likely to be very much lower.
Although negative sentiment towards financial markets currently has the upper hand, market sentiment has a habit of turning on a sixpence – and as market recoveries are often both fast and strong it is important stay invested so not miss out on this potential turning point.
Admittedly, our positive view towards financial markets may not be the consensus, but it should be noted that the media and financial journalists only focus on the here and now drivers, which means their pessimism simply begets more pessimism.
In fact, we believe that in the future, we will look back at this period and it will be obvious to see the advantages of staying invested versus moving into cash, as the current period is a much better entry point into financial markets than an exit point into cash deposits. Financial market sentiment will undoubtedly turn, and we believe it is better to be invested ahead of this than investing afterwards (hence our view that investing is about the ‘time in’ rather than ‘timing’ the market).
This is not to say that we won’t see further volatility, as financial markets tend to be highly sensitive to the latest data or news release and have a tendency to shoot first and ask questions later, but it is worth highlighting that data from the annual Equity Gilt Study produced by Barclays, shows that over the long-term the average real annual return on equities has been in excess of 5% (in other words more than 5% above the inflation rate), whereas returns on cash tend to be negative (in other words, less than inflation).
Income Element
Fixed interest securities have fallen over the valuation period, given their sensitivity to inflation and interest rates following hawkish comments from central bank policymakers.
However, we are perplexed by the need for higher interest rates and believe peak interest rates are actually a lot closer than policymakers are currently suggesting.
This means that yields will undoubtedly drop and prices (which move inversely to the yield) will rise – and with inflation slowing, our strategy of holding a diversified spread of secure companies with investment-grade credit ratings and stable income until their maturity continues to look sensible.
Long-Term Growth Element
The weakness in equity markets over the past three months was predominately caused by hawkish central bank comments that suggested interest rates would remain high for some time.
However, with central banks’ inflation targets clearly in sight, the odds of central banks keeping monetary policy tight is unlikely. In fact, we believe that interest rates will be lower this time next year.
Additionally, given the big picture is one that shows companies globally have actually coped very well with coronavirus, the war in Ukraine, inflation, slow economic growth and higher interest rates, our fundamental views remain the same. This positivity, coupled with the declines we have seen in equities (which only makes the valuation backdrop more supportive), helps set the stage for equities to push higher on any positive news.
During the valuation period the major transaction to note was a slight decrease in your exposure to US equities.
However, this will only be temporary as it is part of bigger rebalancing exercise where we plan to shift the focus of the US holdings away from expensive, high growth companies as we are mindful of how strongly AI-related companies have performed over the past few months, towards more value-orientated companies and smaller companies.
Funds we use here that will see a notable net reduction include Natixis Loomis Sayles US Equity Leaders and UBS US Growth, while those seeing an increase include Artemis US Smaller Companies and M&G North American Value.
Once completed, exposure to the US will see an increase. US consumer spending has been resilient (the consumer accounts for around two-thirds of the US economy), which has fed into improving corporate profit forecasts – which is a powerful tailwind for the US equities, especially if, as we believe, the Federal Reserve, the US central bank, pauses its interest rate increases.
In the UK, we sold the entire holding of the building materials group, CRH, following the change of its primary listing to the US and initiated a position in Halma. Halma is a global group of life-saving technology companies that provide innovative products and services that help solve many of the key problems facing the world today.
For clients with Ethical portfolios, the performance over the valuation period has unfortunately been disappointing. Given the smaller universe of stocks available, Ethical Funds tend to have a bias to smaller but faster growing companies. Obviously, smaller companies tend to be higher-risk, while growth companies (in other words, those that have a lot of profit potential in the future) have been hurt by higher interest rates, as higher interest rates makes the discounted value of those future profits less attractive. Furthermore, these fund’s lack of exposure to industries like oil & gas which have performed well recently as the oil price has risen following news that OPEC was planning to cut production.
Investment Management Team