by Tim Sharp, Research by Jack Williams
Following three consecutive months of declines, November caught investors by surprise, delivering a notable rally in excess of 9% within global equity markets. This has primarily driven by a belief that the path of interest rates will be lower rather than higher going forward.
Technology related stocks have continued to lead the market higher, with the sector gaining 14% as the impact of falling interest rates is discounted. Energy was the market laggard, tracking underlying weakness in the oil price and souring economic sentiment.
The US took pole position in this push higher in markets, outperforming the rest of world in USD terms, while the U.K was the region with weakest performance with a question mark hanging over themselves as investors look to assess the viability and health of its economy.
Further demonstrating the impact interest rate expectations are having on the market, correlations amongst asset classes remains broadly elevated, with global fixed income rising 2.8%. In terms of global yields, the US and European curves saw a bull flattener and in line with the risk on mentality, credit spreads tightened. A bull flattener occurs when longer term rates fall faster than shorter term rates.
Having underwhelmed this year, real assets saw a rally as a result of low valuations and being highly sensitive to interest rates. Copper led industrial metals higher as sentiment warms ever so slightly towards China. The most outsized returns came from the areas that have been most punished over the past year, with real estate being the notable standout as investors seek to capitalise on the deep discounts available within the space. The strongest performing indices of the period (Brazil, Spain, Korea, and the Dax) are all closely linked to Chinese Demand. This may be a signal of growing investor appetite at the margins.
Inflation was the main narrative of the month with developed markets showing a sustained fall in inflation, with both US core and headline CPI coming in below analysts’ expectations at 3.2% rather than the 4% predicted. In the Eurozone CPI fell to 3.6% and 2.4% respectively, UK CPI fell to 5.7% and 4.6%, which while still falling at a fair pace, is behind the inflation curve seen in the US and EU.
In the US, robust consumers saw Q3 GDP revised higher, while eurozone PMI’s remained in contraction territory at 43.8 on the manufacturing side and services of 48.2. U.K composites surprised investors by moving into expansion territory (albeit ever so slightly) surpassing contractionary expectations with a reading of 50.1 compared to 48.7 expected.
While the debate between soft landing and mild recessionary outcomes continues, policy makers have struck a less hawkish tone in recent weeks. Our core view remains that we are likely to see an earnings recession in the US during 2024, although given the surprising resilience exhibited over the past 12 months, have modest conviction.
Companies do seem to be holding up fairly well considering the sheer pace of these rate hikes with balance sheets still looking robust, especially so in the large cap space however we note that smaller capitalised firms relying more heavily on bank finance may be prone to higher levels of risk.
Europe has been skating around recession throughout this year as it has faced significant headwinds. Combating energy security risks, high inflation brought on by the Ukraine conflict along with weaker Chinese demand. Our research partners A.S.R (Absolute Strategy Research) point out that structural issues could persist within the Eurozone region for a longer period with no solution on the table for Europe’s fiscal framework, furthermore the number of cyclical headwinds being experienced by the region could flatten growth over the coming year which would further complicate their current situation.
As a historically more cyclical market, Europe has been impacted by the ongoing weakness in China. The country’s shift from real estate led investment, to growth in manufacturing has proven more difficult than originally envisioned. This will have a knock on in terms of infrastructure spend, with reduced investment in construction through 2024. This could have implications for China’s medium term growth outlook.
Other emerging market nations have shown fierce resiliency in the face of a strong dollar and heightened US interest rates. We are still confident our that emerging market thesis holds and complements our existing Asia positions. GDP growth in Brazil, India, Indonesia, South Africa, and Turkey has been around pre pandemic levels due to them being further within the cycle than developed market peers. Due to being later in the cycle, this allows these nations who moved to combat rising inflation first, the earliest opportunity to emerge out the other side of this tightening cycle whilst still maintaining good levels of financial health and stability. We saw the weak US dollar through the summer capture the interest of investors towards Emerging Market nations, a return to a weak dollar as markets look forward to rates moving lower may well provide some strength to the sector.
US fiscal policy had been receiving closer attention in recent months. Significant budget deficits at a time of low unemployment, along with the impact of the Federal reserve becoming a net seller through quantitative tightening had been cause for concern. However, there is surprisingly no historical relationship between yields and supply. Current net new issuance of $750bn is in line with historical averages and there is nothing to suggest that when facing recession, the level of quantitative tightening is not amended. It would seem the anxiety was short lived, as the recent potential for the Federal reserve to pivot has dominated fixed income markets.
Gold has continued to perform well, despite a recent backdrop that would historically would have been unfavourable. Greater than anticipated declines in inflation have meant real rates – interest rates less the level of inflation – have been rising. One potential explanation is the uptick in central bank purchases of gold who are price insensitive. Additionally, heightened geopolitical tensions are likely to have driven a flight to safety. The positive trend could still yet continue for gold, if we see falling interest rates coupled with dollar weakness.
To the surprise of many – including us – the global economy has remained exceptionally resilient, despite the coordinated effort of central banks to cool inflation and temper demand. However, as the year draws to a close, our views on markets remain broadly unchanged. We continue to believe certain areas of the market are exhibiting exuberance and potentially vulnerable if the economic environment deteriorates materially.
In keeping with this, we continue to be positioned defensively, with a preference for higher quality companies, whose revenues, and earnings we believe to be far more resilient. Whilst we completely understand markets are forward looking, a significant positive impact from falling interest rates in 2024 has been reflected in the prices of both bonds and equities. A healthy dose of scepticism may be appropriate…!
Although our outlook remains cautious, we continue to believe attractive returns are available for long term investors through a disciplined and risk-controlled approach.
Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.
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