Commentary on March 2023
Markets experienced a sharp increase in volatility during March, as a mini crisis in the
financial sector claimed three mid-sized US banks in the space of 10 days. This was
followed by the shotgun wedding of Credit Suisse to rival UBS in Europe, sparking a
global sell-off in bank shares as investors worried about who might be next. US
policymakers moved quickly to limit the fallout, announcing a range of support
measures that included a guarantee for all depositors and a temporary lending
programme to supply liquidity wherever needed. Markets were also soothed by a
sharp decline in bond yields on hopes that the Federal Reserve might postpone plans
for a rate hike to avoid further financial stress. By the end of the month bank stocks
had stabilised and most markets closed broadly flat. However, UK equities declined
3%, hampered by a relatively high exposure to financials and other cyclical stocks.
Elsewhere, the oil price jumped 8% on the back of a surprise cut in oil production by
OPEC. The price of gold also rose sharply, clearing the important $2000 level to
touch a new all-time high.
Following a series of surprisingly strong economic data for January, more recent readings have painted a picture of weaker growth that, compounded by tighter credit conditions following recent bank failures, has increased the odds of a global recession. The US labour market has finally started to slow: a surprise jump in the number of official vacancies in February saw job openings rise above 10 million for the first time since May 2021. Growth in wages also slowed to 2% year on year, down from a peak of 8% in April 2022. Headline inflation dropped from a recent peak of 9.1% to 6.0%. In contrast, the UK inflation figures were particularly poor. Consumer prices rose by 10.4% year on year, an increase from 10.1% for the previous month, with gains driven by an eye watering 18% jump in food prices. Going forward, the rate of inflation should finally start to decline as year on year comparisons for energy prices become less demanding. However, the OBR’s forecast of a fall to 2.9% by the year-end is looking increasing optimistic. On the flip side, the economy and earnings are continuing to fare better than expected.
Central Banks continued to raise rates across major economies, but downgraded the magnitude to 0.25% in most cases. The key take-away is that the outlook for growth might well be slowing but the battle with inflation is not yet over.
March was the month that saw the financial repercussions of higher rates finally
starting to bite, although there have been other warning signs of trouble. The UK’s
pension fund crisis last September was an earlier example of what can happen in
response to the fastest rate hiking cycle in decades. The world has become used to
ultra low interest rates for a long period of time and hence it is no great surprise that
some institutions were ill prepared for a return to more ‘normal’ levels.
At the time of writing it appears that contagion from the banking drama has been contained. SVB and Signature Bank were speciality banks, overly focussed on technology start-ups and the crypto space. Poor internal risk management compounded their problems. Financial sector balance sheets are generally much more robust than in the lead up to the last financial crisis, with regulators requiring a much greater capital buffer. Central banks have also demonstrated that they will not hesitate to act if required.
These events have, however, created a dilemma for policymakers – should they pause and assess the implications of recent hikes on financial sector stability and the wider economy or continue the fight against inflation, which is not yet won. Investors are once again betting that they will capitulate soon but further evidence of a slowdown will likely be required for this to occur.
The UK economy is proving resilient despite much anticipated weakness. Retail sales have continued to grow – it seems that as long as consumers have jobs they will keep spending. Only a few months ago the Bank of England was telling us that the economy was at the start of what would be the longest downturn since the global financial crisis. It now predicts that a recession will be avoided altogether and expects unemployment to remain flat. It is hardly surprising that markets are confused.
Despite increased volatility, global equity markets have delivered positive returns for
the year to date and remain up strongly from October’s low. Over this time they have
weathered elevated inflation, hawkish central banks, the threat of a recession and now
a mini banking crisis. Having increased exposure to equities in October we are happy
to wait for fresh opportunities before committing any remaining cash.
The investment landscape has undergone much change over the past year and continues to evolve – as old leaders have faltered the baton is being past to the new growth drivers. It is less likely that the US will lead the next cycle in financial markets. We believe that once current uncertainties start to recede, there will be material opportunities for investors in other areas such as Japan, Asia and emerging markets. In the meantime our portfolios are positioned to weather a number of potential outcomes. Exposure to gold is also providing positive returns and diversification while we wait for the macro outlook to clear.