Commentary on September 2023
Global markets continued to drift gently lower in September from highs reached in late July, with equities and bonds both falling by 0.7% in aggregate. The declines in both asset classes were concentrated in the US. In part this was driven by Powell’s ‘higher for longer’ message on US interest rates. The political battle over funding the US government also served to highlight the widening budget deficit that has played a secondary role in driving up interest rates. The yield on the 10-year US treasury bond increased to 4.8%, a level not seen since 2007. The surge in yields had a negative impact on growth stocks, in particular the mega cap technology issues, which were vulnerable to a correction following their strong recovery so far this year. Falls were compounded by negative stock specific news flow. The US Federal Trade Commission sued Amazon for allegedly monopolising online marketplace services, overcharging sellers and stifling competition, underscoring the US government’s push to rein in the concentration of corporate power. Other regulatory agencies have also filed antitrust suits against Google and Facebook parent Meta. There was further concern over how a Chinese ban on Apple’s iPhone and other foreign-branded devices among government-controlled organisations could impact the industry.
The US debt ceiling battle is coming to a head once again. Congress passed a ‘stopgap’ bill to avoid a shutdown and fund the government until 17th November, while concerns about fiscal discipline in Congress led to an internal power struggle that resulted in Republican Kevin McCarthy becoming the first House Speaker to be ousted from the role. However, despite political uncertainty and the continued march upward in interest rates, economic data for August provided fresh evidence of underlying US macro resilience. Retail sales and manufacturing PMIs both rose by more than expected. The labour market remained strong: jobs continued to be added at a healthy pace even as vacancies reduced somewhat, and real wage growth held firm. Inflation news was also favourable, with further evidence that momentum is slowing. The Federal Reserve’s response was to keep rates on hold but caution against any expectation for a dovish pivot in policy.
Elsewhere, UK equities were a notably strong performer, rising 3% over the month. Two key positive factors drove the market higher. Fresh figures from the ONS revealed that the UK has bounced back from the pandemic quicker than previously thought and is no longer the worst performer in the G7. In the three months to June, GDP was 1.8% above its pre-pandemic levels. Previously the agency estimated that GDP was 0.2% below. The revision gives the UK a similar performance to France and a stronger recovery than Germany. In addition, core inflation fell by more than expected in August to 6.2% from 6.9% the month before. In response, the Bank of England finally stopped raising the base rate, choosing to hold it steady at 5.25% at its latest meeting, ending a run of 14 consecutive hikes that began in December 2021.
China’s economy is showing signs of life as a summer travel boom and a hefty stimulus push boosted consumer spending and factory output. Retail sales growth and industrial production both jumped in August from a year earlier, blowing ahead of expectations. The improvement came as the government has continued to beef up pro-growth measures in recent weeks, with further stimulus from the central bank to boost bank lending capacity. These measures should help growth to rebound following evidence that China’s post-Covid recovery has been losing momentum since an initial recovery in the first quarter of 2023. Chinese equities were unchanged on the month.
Crude oil prices have recovered strongly since the beginning of summer, rising from $70 in June to $90 at the end of September on forecasts by OPEC that output cuts from Saudi Arabia and Russia will tighten the market in the months ahead. This is happening at a time when stockpiles at the US Strategic Petroleum Reserve have fallen to historically low levels, highlighting a widening global deficit. Meanwhile demand has remained stronger than expected in Western economies and is now starting to recover in China, a major consumer that is forecast to account for a significant 75% of the total global increase in demand for 2023.
Financial markets have corrected back to support from overbought conditions in July, following what has been a typical pattern of summer weakness. However, the broader uptrend has remained intact, and markets are now reaching oversold levels that have typically coincided with a low. This provides the potential set-up for a seasonal rally during the final trading quarter of the year. Last October we took advantage of a similar buying opportunity, after which markets enjoyed a strong rally in the first half of 2023. At the time of writing, the sudden escalation of conflict in the Middle East may provide a similar seasonal entry point this year.
Inflation and rising rates have been the key themes in markets these past 18 months. More recently as inflation has begun to recede, attention has shifted to the potential for interest rates to peak but remain ‘higher for longer’. We may be moving into a phase where investors are able to catch their breath and adjust to a world where interest rates are levelling out or even easing a little rather than rising relentlessly. This would allow investors to once again focus on the value that has arisen following several turbulent years.
The UK remains at the largest discount globally. This valuation anomaly in part reflects the misplaced belief that the UK is both a growth and inflation outlier relative to the rest of the continent. Recent data, such as the revision to post-pandemic growth by the ONS, is starting to dispel this notion. The UK is also closing the gap in inflation: German inflation is now higher than in the UK. These statistics reveal that there’s not much that is obviously different about the UK that would account for its current discount in valuation terms.
Along with the UK, the Japanese market also offers compelling value. Ongoing reforms in the corporate sector are improving profitability, with a positive impact on both earnings growth and shareholder returns; the latter via higher dividends and share buybacks. This is in addition to support from the macroeconomic backdrop, where following years of deflation, the prospect of wage growth boosting consumption is providing a further potential tailwind for growth in the years ahead.
The Japanese index has been in a recovery trend, reaching its highest level since the stock market bubble burst in 1990. The returns of our holdings in the Schroder Tokyo and Jupiter Japan Income funds have received a further significant boost from our decision to own share classes that hedge the underlying yen exposure back into sterling. This means our portfolios have benefited from both the appreciation of the Japanese market and the appreciation of sterling versus the yen.
The yen is the poster child for currencies that are suffering because of an increasingly wide differential in the level of interest rates when compared with the US. The Japanese central bank has become a standout exception amongst other major central banks in having yet to hike interest rates. Indeed, the Bank of Japan has continued to intervene in Japan’s bond market to keep rates artificially low. The yen has paid the price, as global investors have taken advantage by borrowing in yen to invest in higher yielding assets overseas – the so called ‘yen carry-trade’. As a result, the Japanese currency is now extremely undervalued. However, with inflation in Japan now running above 3%, pressure is mounting on the Bank of Japan to let rates rise, at which point the yen could surge. We have therefore switched back into local currency share classes ahead of any such move. The existing holding in Schroder Tokyo has been retained as our preferred core holding for standard portfolios. However, the Jupiter Japan Income fund has been switched into the Morant Wright Nippon Yield fund, which has greater exposure to value stocks along with a higher yield. An additional holding in the M&G Japan Smaller Companies fund has also been added on higher risk portfolios.