The Evelyn Partners Investment Podcast

Is there room for tentative optimism?

The S&P 500 has just capped its longest winning streak in over a century, encouraged by better data on inflation, economic growth and corporate earnings. However, data remains volatile and it is possible that markets have moved too far too fast. Valuations now leave little margin for error.

July saw the Federal Reserve and European Central Bank raise rates once again, though many economists expect this to be the peak. However, central banks are keeping their options open and have made it clear they will respond to new data as it emerges.

There are also strains in the fixed income market, with credit spreads tightening as economic data improves. While there are still opportunities in both equity and fixed income markets, it argues for a selective and balanced approach to asset selection.

Breaking the bad news cycle

With the S&P 500 up 20% since October 2022, another bull market has begun. To date, it has been led by a narrow group of technology companies, but there are signs it may broaden out in the months to come.

This may create momentum for global stock markets in the second half of the year, even as a recession looms. Consensus expectations are now for a less severe recession than was expected a year ago. Falling expectations of peak US interest rates have also helped stocks to rally too.

The weaker dollar may also be a swing factor for investors. Dollar depreciation is usually indicative of an improving global growth backdrop; it tends to depreciate at times of greater certainty on the economic outlook. These factors may combine to create a better outlook for stock markets in the remainder of the year.  

 

Why the technology sector is defying its critics

2023 has seen a surprising revival in the technology sector. This defied the grim predictions of some investors who saw rising interest rates marking an end to the decade-long dominance of technology stocks. The sector’s strength has partly been driven by the excitement around artificial intelligence and its potential for disruption.

Artificial intelligence could be a major force over the next decade. Its influence is likely to be felt in more industries, and investors need to align themselves with the disruptors rather than the disrupted. Ultimately, new and as-yet-unseen opportunities will emerge as AI grows in power and capability.   

In the shorter-term, the resolution of the debt ceiling has allowed markets to breathe a sigh of relief. In the end, the impact for bond and equity markets was minimal. All eyes will now turn to the next move from the Federal Reserve and the timing of its next rate rise.

Interest rates and the gold price

The gold price has been rising, reaching a record high at over $2,000 per ounce in April. This suggests markets see an imminent end to the rate rising cycle in the US and further falls in the Dollar. Buying from foreign central banks is also driving the gold price higher, as countries seek to diversify their asset bases away from Western government bonds.

Markets believe inflationary pressures are ebbing. In the US, March’s CPI data showed the level of inflation at a two year low, while lead indicators such as falling job openings and lower selling prices show core inflation starting to come down. The exception is the UK, where inflation remains stubbornly high.

The Dollar has been weakening in response to an expectation of slower rate rises from the Federal Reserve. This may continue as other countries, such as the Eurozone, continue to raise rates, Foreign exchange traders may also pay attention to the growing deficit in the US, which increasingly requires foreign capital to support it.

Have central banks done enough to stop contagion?

Financial markets have been dominated by the fallout from the banking sector turmoil in March. The problems at Silicon Valley Bank and Credit Suisse were more a consequence of poor management than a broader fragility in the global banking system, but it has still unsettled bond and equity investors.

It has also prompted a reappraisal of interest rate expectations. Bond markets now expect the Federal Reserve to cut sooner. They believe banks are likely to rein in lending, which will slow economic growth and give central banks greater flexibility on future rate rises.

The impact for stock markets is not yet clear. They remain trapped in a holding pattern, waiting for greater clarity on interest rates. It is possible to build a gloomy or optimistic scenario. While inflation still looks sticky and some economic weakness appears inevitable, China’s reopening is fuelling growth and a degree of bad news is already priced into markets.  

Can the global economy avoid a hard landing?

There has been encouraging data on the health of the global economy in recent weeks, with employment, inflation and consumer spending all giving cause for optimism. There is increasing confidence that a hard landing may be avoided, in spite of higher interest rates.

However, financial markets have wobbled in recent weeks. In particular, investors continue to worry about further rate rises from the Federal Reserve, even though inflationary pressures appear to be easing. The US central bank has reiterated its commitment to price stability above economic growth.

Closer to home, the UK has agreed a new Brexit deal, potentially solving the thorny issue of the Northern Ireland protocol. This should be a boost for UK businesses, at a time when the domestic stock market looks cheap relative to its peers and its dividend yield is high. This may boost investor confidence in the UK market.

Mixed messages dampen investor enthusiasm

Global economic data is delivering some mixed messages on the outlook for the year ahead. There are encouraging signs on inflation, with energy and food prices gradually falling. However, employment data remains buoyant and a shock jobs number at the start of February gave investors a jolt.

The major central banks of the US, UK and Eurozone remain tight-lipped about whether a turn in the interest rate cycle is likely. They all raised rates in their last meeting, but at a slower pace than seen in 2022. Bond yields ticked higher in early February, suggesting that investors no longer have faith that a pivot is imminent.

Equity markets reversed their recent run of strength as technology earnings disappointed. While these are economically sensitive sectors, it is clear that consumer and business spending is slowing. While valuations are still compelling in some areas, a cautious approach is necessary.

 

Equity markets make a bullish start to 2023

Better news on inflation has sent markets higher in the early weeks of 2023. The reopening of China has seen a strong performance from Asian markets, as the Government puts its zero-Covid strategy behind it. Easing supply chain bottlenecks and falling commodity prices are also improving risk appetite.

However, recession remains a plausible outcome for most of the world’s largest economies. Consumers and businesses need to adjust to higher costs and a tougher environment for borrowing. Against this backdrop, some caution is still warranted.   

Yield may prove an important factor in the year ahead. High-dividend companies are likely to be popular with nervous investors. They may gravitate to sectors such as energy, consumer staples and utilities, which all have high yields. Fixed income also has some appeal after a tough year.

A bear market rally, or the start of a new bull run?

There’s been a meaningful rally in equity markets since mid-October, fuelled by hopes that inflationary pressures are moderating. Resilient corporate earnings have also played a role in supporting markets. However, few believe stock markets have turned a corner permanently, with plenty of bad news still to digest in the year ahead.

On the other hand, bonds could be back. As yields have risen and markets have priced in higher rates, conventional government bonds have more appeal. Ultimately, they may be able to resume their traditional role in a portfolio – income generation, capital preservation and diversification.

There has been better news on US and European inflation, with some easing of inflationary pressures. While this has buoyed investors, it is unlikely to prompt a significant change of heart from the Federal Reserve – at least in the short-term.

Things can only get better?

Financial markets have remained volatile over the past month. In some cases, notably the UK, there were clear reasons for concern. However, some stability has returned to UK gilts and equities since Rishi Sunak has taken the reins as Prime Minister, rolling back the measures in the mini-budget and introducing greater fiscal discipline.

For the rest of the world, it’s just a question of watching the Federal Reserve. As Cherry Reynard and Daniel Casali discuss in this podcast, there are brighter signs on inflation, with expectations falling. It appears many developed market economies may yet avoid a wage-driven inflationary spiral.

Financial markets are also watching the trajectory of commodities markets. While oil prices have dipped recently, oil cartel OPEC+ seems determined to keep prices higher. Energy is becoming a geopolitical weapon, and ongoing high prices may disrupt the best-laid plans of the Federal Reserve.