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Investor confidence has been knocked by the realisation that interest rates could stay higher for longer – causing markets to have a turbulent month in October. But this could all change in the last couple of months of the year.
October was offering plenty of tricks and not so many treats, as there was a sharp sell-off in the bond market. This was brought on by uncertainty as to when interest rates would start coming down, along with a stronger-than-expected US economy.
While this may sound like bad news, it could actually create opportunities from an investment perspective. Lilian Chovin, Head of Asset Allocation at Coutts, the bank behind the NatWest Invest funds, says this could be a good time to strike while the iron is hot.
He says: “While investors were feeling positive over the summer, nerves are now getting the better of them a little. But that could be a good thing. It could mean investment opportunities lie ahead – the chance to invest at a good price – and we believe we could see markets recover over the remainder of the year.”
Despite the uncertainty from investors, there are some positive signs ahead. Inflation is continuing to fall, economies are holding strong and there are signs we’re nearing the peak in interest rates. With this in mind, the experts at Coutts have made some adjustments to the NatWest Invest funds.
One change includes an increase in global stocks. This is because of the influence the US has on global markets. The country’s current economic resilience could have a positive knock-on effect on wider regions and their stock markets.
Also, the possibility that the run of interest rate rises could be coming to an end means there’s a more positive outlook for bonds. So Coutts also bought more long-dated US government bonds, which could benefit from this.
US earning season began in mid-October – where companies report how well they’ve done for the previous three months – and there were high expectations to beat.
Some industries, like tech companies in the US, had a stellar first half of the year which meant they were under even more pressure to keep this momentum going. While announcements were positive, they still fell short of where investors thought they would be, so some big names saw their share prices drop.
Howard Sparks, US Equity Research Analyst at Coutts, explains: “We’ve seen negative market reaction to generally positive news on company earnings. With expectations being so high going into this earnings season, any signs of weakness were severely punished.”
This reaction re-emphasises the nervousness from investors and how sensitive markets can be during these times. But it’s worth highlighting that this negative reaction and related weak market performance isn’t that uncommon, and we see current levels as being potentially attractive given our expectation for things to improve for the rest of the year.
As inflation continues to ease, there’s a growing feeling in financial markets and among economists that interest rate rises could finally be nearing an end.
America’s central bank the US Federal Reserve (Fed) held interest rates steady at its most recent meeting. But with renewed strength in the economy, those rates may need to stay higher for longer to tame inflation.
The Bank of England (BoE) also left interest rates unchanged at 5.25% – the first pause since November 2021. The decision followed UK inflation dropping from 6.8% for the year to July to 6.7% for the year to August.
While this is all very encouraging, the BoE and Fed remain cautious, both stressing we’re not out of the woods yet and further hikes may be necessary.
Lilian Chovin, Head of Asset Allocation at Coutts, the bank behind the NatWest Invest funds, says this is only to be expected.
“Central banks don’t want to be calling victory too early and there’s uncertainty about the level at which inflation will stabilise,” he says.
“In periods where rate rises could be coming to an end but it’s by no means definite, there tends to be increased market uncertainty. There’s still some concern that more rate hikes may be necessary if inflation picks back up. After all, you only know it’s the last hike a while after it’s happened.”
The US economy shows signs of strengthening, with shoppers still spending and inflation still falling, while there’s growing activity globally too.
Historically, such conditions have been positive for stock markets. There is still a risk of a recession in the US, which would hit markets worldwide. But the Coutts team’s own recession indicator shows that the chances of one have been easing a little since February. A stabilising manufacturing sector in America even suggests the country may avoid a severe downturn.
Given this backdrop, the experts at Coutts have been positioning their investments towards new opportunities. For example, they sold some of their US government bond holdings and increased their stake in UK corporate debt, which currently offers better income.
Oil prices have surged to their highest level in more than a year, raising fears inflation could rise again. Brent crude soared to over $97 a barrel and some analysts are predicting it could even breach $100.
The spike comes after two of the world’s biggest oil producers, Russia and Saudi Arabia, announced they would extend their voluntary production cuts until the end of the year.
Lilian says it shouldn’t cause too much of an issue for the fight against inflation though.
He says, “While the rise in the oil price is not going to help inflation, in order for it to have any impact on prices it will have to remain elevated above $100 a barrel for some time.”
Why is oil important for investors?
The price of oil is a critical barometer for investors worldwide, driving major movements in the global economy and stock markets. As a core commodity, the price of oil impacts the profitability of many industries and individual companies.
Oil prices affect everything from airlines and automakers to plastic producers and shipping companies. Even small fluctuations in crude prices can have an oversized impact across industries.
Unfortunately, August was a tough time for equities. Global stockmarkets lost ground at the beginning of the month as confidence dropped due to rising bond yields and concerns about the slowing Chinese economy. However, despite that initial volatility, the market’s mood then lifted as the month went on, boosted by some strong earnings reports.
China’s post-pandemic recovery has failed to fully materialise following declining global orders for exports and sluggish domestic demand. The Chinese property crisis is also worsening, with two major developers facing severe financial difficulties. Furthermore, the world’s second-largest economy is grappling with deflation, stoking fears of Japanese-style stagnation. Chinese youth unemployment has reached an all-time high, exceeding 20%.
China’s central bank has cut key interest rates for the second time in three months in a bid to revive the economy, but most analysts agree it will have little impact. Any downturn in China is likely to weigh on Germany’s economy, which is heavily dependent on China for trade. Germany is Europe’s biggest economy and there are fears that a slowdown in China could ripple out and affect the wider euro area, which is still recovering from last year’s energy shock.
Sven Balzer, Head of Investment Strategy at Coutts, says: “Markets rebounded after some volatility, though concerns linger about slowing growth and property woes in China. Its economy was meant to drive global growth his year, so the dramatic slowdown is sending alarm bells out around the world.”
The global economic outlook is still brighter than it was at the beginning of the year. Inflation is coming down in most developed economies, interest rates look like they are now peaking, and growth remains resilient in the US. While we're still cautious overall, we've recently increased our investment in equities across our portfolios and funds, moving towards a more neutral position when compared to our benchmark).
At the beginning of the year, concerns about a potential US recession were high. However, the economic situation has improved in recent months. So, with inflation falling in the US and the interest rate hikes nearing an end, equities have performed better than anticipated and could continue finding support in that improving backdrop. We’ve sold some emerging market bonds and used the proceeds to buy more of the US equity markets.
We've also tweaked our bond investments to reflect global interest rate rises, focusing on where we see opportunities. Unlike the very resilient US, European economies have started to show some signs of a deteriorating economic outlook. Given the expected impact on inflation this divergence between the two regions could create, we've reduced our allocation to US government bonds and increased our holdings in European government bonds. Furthermore, we've increased our holdings in UK corporate bonds, which are attractively valued and could benefit from the ongoing drop in British inflation.
Although there have been numerous economic challenges, the US economy has continued to grow this year, performing better than many other wealthy nations. Out of the G7 countries the US has managed to record the strongest post-pandemic recovery, while also seeing inflation come down faster than other economies. The American labour market also shows surprising strength, with the unemployment rate remaining near record low levels.
The ongoing strength of the US economy also means the anticipated recession may materialise later than originally expected. The economy is holding up well thanks in large part to a spending spree by shoppers, whose pay packets have been boosted by strong jobs growth and rising wages. Despite the US Federal Reserve’s most aggressive rate-rising cycle in 40 years and still-high inflation, retail spending in July rose for the fourth month in a row, going up by 0.7%.
However, there are some signs consumers are having trouble keeping up with rising prices. US households have racked up more than $1 trillion in credit card debt and late payments are rising, which could spell problems for the economy further down the line.
The mood among investors has continued to lift this month as inflation falls in the US and UK and employment numbers remain resilient.
It’s a particularly good story in the all-important US, crucial to global investors, with annual inflation dropping to 3% in the 12 months to June from 9% at the same point last year. This has cheered investors as it suggests a pause in investment return-denting interest rate rises.
Markets now expect America’s central bank, the US Federal Reserve, to raise interest rates one more time, then stop – and potentially start cutting them next year. Meanwhile, US banks recently announced a relatively good set of financial results, and a much-anticipated US recession, while still quite possible, could now come later than expected.
The interest rate story is different in the UK, where analysts expect them to peak at just below 6% (they’re currently at 5%). But a larger than expected drop in inflation in the year to June further encouraged investors.
A respected measure of the market mood is the CBOE Volatility Index, or VIX, otherwise known as the ‘fear index’. It looks at potential, future volatility in the S&P 500 to measure how investors are feeling.
At the time of writing (21 July 2023) it was at 13.8, and a score of 20 or lower is seen as a sign of moderate volatility. In March 2020, when Covid was dominating the headlines, it peaked at above 80.
Lilian Chovin, Head of Asset Allocation at Coutts, the bank behind the NatWest Invest funds, said: “We’re currently in calm waters. Inflation is falling against a backdrop of still-resilient economic growth in the US. It’s coming down without much economic pain, with almost no jobs lost. The UK is a little behind in the process, but ultimately it should follow suit.
“We’re not there yet, we’ll need to see more proof points to be sure, but markets are certainly looking more positive than they did six months ago.”
The Coutts team is keeping this positivity in mind when considering its investment positioning. While they’re still adopting a conservative approach for now, they’re watching the mood shift closely.
“I would say we’re moving from a more conservative attitude to a more constructive one,” Lilian said. “Risks remain, but we’re monitoring developments continuously and stand ready to act as soon as opportunities arise.”
One example of this slight change in outlook is the bank’s view on a potential US recession, which has softened a little.
“Our US recession indicator is still quite high and it remains a risk, but we’re adjusting our expectations in light of recent data,” Lilian said. “We saw some weakness in the US housing sector and other interest rate-sensitive areas earlier this year, and this often signals a recession. But those sectors now seem to be stabilising and we haven’t seen any contagion elsewhere.”
He added: “The US economy is relatively strong and its people still have money to spend. So if a recession did happen, it would likely be later than first anticipated. And even if it happens, it’s so well anticipated by markets its impact could be smaller than in previous times.”
There was a noticeable mood swing in markets for June as positive news just kept on coming out of the US. The mood among shoppers rose, while inflation continued to ease. And despite the backdrop of climbing prices and rising interest rates, Americans continued to flaunt their cash as retail sales unexpectedly jumped in April.
The US economy looks to be holding up rather well, with its job market defying predictions of a slowdown by adding 339,000 new jobs in May. But more importantly, the US Federal Reserve – America’s central bank – paused its rate hiking cycle for the first time since March 2022. It’s now waiting to see what impact the current high rates will have on inflation and the wider economy.
But while the US takes a break from raising interest rates, the UK is still trying to tame rising prices. Core inflation – which strips out fast-changing fuel and food prices – is still on the up in the UK. The Bank of England (BoE) is now feeling the pressure to take back control, and markets now believe that interest rates could go as high as 6%.
On the back of these expectations, UK government bonds suffered as yields soared to their highest levels since the global financial crisis in 2008 (as yields rise, prices fall).
Overall, unless the current trend of stubbornly high inflation drastically changes, the outlook for the UK remains challenging.
The US is defying the odds because elevated inflation and soaring interest rates have had minimal impact on businesses and the public so far this year. The typical American has seen their wages steadily grow and is still spending as a result. The US labour market as a whole is showing resilience as businesses keep profits high, meaning staff have managed to keep their jobs.
But we’re not writing off a US recession just yet. We’re yet to see the full impact the rapid rise of interest rates has had on the economy. The US manufacturing sector is showing signs of slowing as a drop in sales growth, combined with rising labour costs, starts to take its toll.
For now, though, from an investor perspective, all eyes are on falling inflation and the possibility of a ‘soft landing’ for America’s economy – an uneventful slowdown.
On the other side of the coin is the UK. We’ve managed to avoid a recession, rescued by a rebound in people’s spending that sparked some economic growth. But inflation remains public enemy number one. With the unemployment rate at a near all-time-low and wage growth picking up momentum, prices are still rising despite the BoE’s rate hiking efforts.
Elsewhere, economic momentum is starting to slow across Europe. China is facing a slowdown that’s having a domino effect on Germany – Europe’s biggest economy – and the rest of the continent.
Artificial intelligence (AI) is causing a stir on Wall Street. Leading US stock markets are steadily higher over the last couple of months, driven mostly by a select few technology giants that are at the centre of the AI revolution. Since ChatGPT burst onto the scene, companies that can leverage on the technology are looking to keep up with the pace, with around 70% of firms expected to be using AI by 2030, according to McKinsey.
As a result, double digit percentage gains in technology stocks contrast with their negative performance last year. Questions are now being asked around whether or not the rally is sustainable. The experts at Coutts, the bank behind NatWest Invest, embrace the potential for technological disruption but are cautious about chasing the market higher.
Howard Sparks, US Equity Research Analyst at Coutts, says: “The rapid rise of AI has created a frenzy on Wall Street with investors piling into shares of big tech companies that are leading the field. However, it’s not very healthy that such a small number of stocks are driving the market as this isn’t customarily a signal of a sustainable rally.”
Even though the US market is performing well so far this year, economic data still suggests that a US recession is on the cards over the next year, even though the labour market remains strong and wage growth is healthy. Inflation is falling but is still above the US Federal Reserve’s target. With all this in mind, Coutts maintains conservative positioning in its investment portfolios.
This side of the Atlantic, inflation is more stubborn. Although rising prices are starting to ease, UK core inflation (which strips out volatile energy and food costs), has reached a 30-year high of 6.8% year-on-year. This is a key figure that the Bank of England takes into consideration when deciding on interest rate moves, and so further interest rate hikes are expected in the coming months.
With further interest rate rises on the cards, UK bond yields have gone up (which means prices have come down). Our UK government bond exposure remains low as they only account for 1.7% in our balanced funds.
The US government is close to running out of money. In January, the government reached its limit of $31.4 trillion and has been battling with the divided Congress to raise the debt ceiling, which is the amount that the government can borrow.
This isn’t the first time this has happened though. According to the US Treasury, since 1960, the US government has raised or altered the debt ceiling 78 times. In 1995 and 1996, clashes over federal spending between the Republican-controlled Congress and President Bill Clinton resulted in the government being partially shut down twice for a total of 26 days, which didn’t trigger a default on US debt. There was also a stalemate between President Barack Obama and the Republicans in Congress in 2011, but an agreement was reached to raise the debt ceiling in the final days.
Negotiators from the Democratic and Republican parties reached an agreement at the end of May, which received the green light from the US House of Representatives shortly after. Historically, debt ceiling standoffs have ultimately been resolved, given the economic and financial market ramifications that can follow debt default events.
Welcome to the big battle of the bulls and bears!
We’re seeing mixed signals at the moment. Stock markets have recovered from a mid-March slump, which is raising investors’ confidence. But most major signals show a recession knocking on America’s door that could impact markets worldwide.
So an ongoing battle between what investors call “the bulls and bears” – the optimists and pessimists – continues. Some think things are looking up, others see clouds on the horizon.
Because of this uncertainty, the experts at Coutts behind the NatWest Invest funds are playing it safe for now.
Lilian Chovin, Head of Asset Allocation at the private bank, said: “We’re led by data and analysis, not hunches. While the stock market rally is creating renewed optimism among some investors, deteriorating macroeconomic conditions, falling house prices and tighter bank lending remain reasons to be cautious and patient in our view.”
This ‘wait and see’ approach is reflected in Coutts’ investment positioning at the moment.
Overall, the team is defensively positioned on stocks and has a high allocation to government bonds, which are relatively more secure and provide useful diversification.
In fact, Coutts has progressively bought more government bonds as a US recession became more likely. And there is even more prudent positioning within that. They bought more US government bonds given higher yields, and sold Japanese government bonds due to some specific interest rate uncertainty in that region.
In April, they slightly reduced their exposure to high yield corporate bonds, which come with more risk, and bought more higher quality investment grade bonds, which could benefit as inflation and interest rates start to settle.
For some time now, market performance has been dogged by rising interest rates and ever-higher inflation, both of which can be bad for stocks and bonds. But at the start of May we saw signs this could change – in the US at least.
The US Federal Reserve (Fed), America’s interest rate-setting central bank, raised rates by another 0.25%, but suggested that could be the last hike for the time being. Their actions and comments matter because what happens in the world’s biggest economy impacts investors across the globe.
“The overall aim of raising interest rates is to bring rising inflation under control, and we think headline inflation will keep dropping at least until the summer,” says Lilian. “So the Fed announcing a pause in raising rates isn’t a surprise.
“The central bank has effectively suggested interest rates may have reached their peak, which could mark an important turning point for markets. But we’ll need to wait to see what happens next.”
He adds, “Markets expect significant rate cuts into next year as the current, high rates take their toll on the US regional banking sector, which could damage the economy further while a recession looms. But while that’s quite possible, it’s by no means certain.
“As always, we’ll continue to monitor and analyse the data and position our customers’ investments accordingly, based on what the facts tell us about upcoming market conditions.”
March was an eventful month for the financial sector as banks in both the US and Europe came under pressure. In the US, we saw the collapse of Silicon Valley Bank (SVB) as rising interest rates impacted its lack of diversification and uncommon business model. And across the Atlantic, it was Credit Suisse’ long standing issues that led to it being bought by rival bank UBS.
These events were very specific to the banks concerned rather than part of any wider, systemic issue. Investors’ nerves were soon settled by how quickly and effectively the authorities were able to step in and help ease the stress. The US Federal Reserve (Fed) provided emergency funding to the wider banking sector while Swiss regulators worked overtime to get the Credit Suisse-UBS deal finalised on short notice.
In the all-important US, there was uncertainty around what the Fed might do ahead of its rate announcement in March following what happened to SVB. Investors and economists were divided on whether the central bank would cut, stick or raise rates further. In the end, it announced another 0.25% hike, but comments from Chairman Jerome Powell suggested the peak could be near. Likewise in the UK, the BoE also raised rates by 0.25%, in line with expectations.
The Fed said it took the recent situation in the banking sector into consideration when making its decision to raise interest rates, which suggested rates could near their peak sooner than expected. The language used around any further rate rises was softer as the central bank acknowledged the stress any further limits on bank lending could mean for the economy. However, Jerome Powell wouldn’t comment on when rate cuts might begin.
Despite the pressure that elevated rates are having on markets and economies, central banks across the globe have said that bringing down inflation remains the top priority. In the US, year-on-year inflation fell to 6%, down from 6.4% the month before. This still remains above the Fed’s target of 2%. For the UK, however, inflation is proving a little sticky having picked up some pace again after falling over the previous three months.
Our funds and portfolios remain cautiously positioned. We became more defensive ahead of March’s events as our outlook for 2023 predicted a recession, which we believe could still be on the cards for the US.
Markets built on January’s positive start, but with some small but important differences.
Rising prices remained at the forefront of investors’ minds as the latest round of inflation numbers showed not all costs were easing as quickly as initially hoped. In the US, there was a slight slowing in the rate at which prices increased, but there were some elements (including shelter costs) which proved to be stickier. As a result, markets are expecting interest rates may need to stay higher for longer.
It’s a year since Russia’s invasion of Ukraine, but there are still no signs of an end to the conflict. At the same time, the shooting down of China’s spy balloon by the US added to the growing tension between the two superpowers. All of this added to an increased focus on geopolitics in February.
Expectations of interest rates staying higher for longer along with rising geopolitical concerns led to a slight weakening in bonds (as bond prices go down, yields go up) and a return to a slightly stronger US dollar. And at the time of writing, stocks from the technology sector are slightly up for the month, outperforming the market and last year’s winners like energy.
In Japan, Kazuo Ueda has been nominated as a potential new governor of the Bank of Japan. If he gets the job, many analysts think he may do away with long-standing, tight controls the bank has to help make it attractive for people and companies to borrow. The idea being that this in turn encourages people to spend more, stimulating the economy but also causing more inflation. While low inflation or even deflation has been a longstanding problem in Japan, recent elevated numbers suggest it could be time for the Bank of Japan to turn less accommodative. Such a change could cause much uncertainty for global markets and dent the performance of Japanese Government Bonds.
But the experts at Coutts who run the NatWest Invest funds had already reduced their investment in Japanese Government bonds in January, seeing some uncertainty ahead.
While some of us may have suffered the January blues, markets started off the year on a positive note having finished the month with strong performances across the board.
Key drivers for this upbeat start include Europe’s mild winter – which brought down projections for future energy prices – and China reopening its economy. More optimism from central banks that inflation could continue to slow down in Europe and the US also helped bonds and equities finish January positively – although risks of recessions remain.
Rising inflation seems to be behind us now. And although it’s still quite high, investors believe central banks won’t raise interest rates as much as last year to try to tame it. That’s potentially good because rapidly rising rates tend to be bad for markets.
But despite the positive start, the all-important US could still have a challenging year ahead with 2022’s interest rate rises taking their toll on its economy. It’s becoming difficult for people to borrow, which is causing a dip in retail sales. This, along with a weakening housing market, could cause its economy to slow down later this year.
Markets are in a transition phase right now, as Lilian Chovin, Head of Asset Allocation at Coutts (the bank behind the NatWest Invest funds), explains.
“On one hand, inflation pressures have eased, but it’s too early for central banks to start cutting interest rates,” he says. “On the other, China is opening up while the US economy continues to slow down and could move toward a recession.
“With this uncertain landscape front of mind, we’re managing our portfolios and funds cautiously.”
Across transport, NHS and other industry walkouts, the UK witnessed 25 days of strikes in December, and 20 days in January. This brought the total number of strike days in 2022 to a 30-year high, according to the Office for National Statistics.
While the reasons behind the strikes vary from sector to sector, one common factor is the cost of living crisis, with inflation on goods and services not being matched by increases in people’s wages. With a very low unemployment rate and a shortfall in available staff, workers are in a strong position to negotiate pay raises.
So what’s the impact of all this? Well, for the Royal Mail, its recent staff strikes cost the company £200 million. For the wider economy, it’s not quite so easy to calculate.
While the strikes are impacting the day-to-day lives of most people, their spending is unlikely to dwindle – they’ll just spend their cash in different places. For example, instead of buying their coffees or lunches at stores close to their offices, they’ll likely just buy them closer to home.
Overall, looking at recent examples in other countries, industrial actions have generally had a limited impact on economies. So we don’t expect recent strikes to be a key driver of the UK economy in 2023.
Although it’s been the talking point of the year, it looks like inflation across the world has finally reached its ceiling. Annual inflation numbers have started to fall but remain at multi-decade highs. The rising cost of goods in the US has been slowing since July, but the UK and the rest of Europe only saw a deceleration in November.
Central banks have had an ongoing battle trying to tame climbing inflation by raising interest rates. While this appears to have worked, we believe central banks will remain cautious and won’t reverse their rate hikes quickly. We think interest rates will peak in 2023, but it’s unlikely to happen until later this year.
As fears of a recession began to creep in towards the end of 2022, both stocks and bonds fell in December – a pattern seen throughout the year.
Following the round of interest rate hikes from central banks in November, markets turned their focus to the likelihood of a recession across Europe and the US. With what we know already, it’s likely that the UK and Europe have already fallen into recession. We’re just waiting for confirmation from the official statistics. For the US, it doesn’t look like they’re in a recession yet, although it’s possible its economy will contract in 2023.
Having been in and out of lockdown throughout much of 2022, China began relaxing its Covid measures in November. While this was initially welcome news for investors, a rapid rise of cases has caused further chaos, with hospitals reportedly overwhelmed.
Despite positive developments in China, with a renewed focus on economic growth, we continue to see some specific risks linked with the lack of political transparency. As a result, we remain somewhat cautious on some parts of the Chinese market, but like broader emerging market stocks. Of course, what happens in China has a big effect on general emerging market exposure, so we’re keeping an eye on developments there.
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