The second quarter of the year was filled with hope that interest rates were nearing their peak, and markets could look beyond an environment where rates continue to move upward. The third quarter of 2023 has shown inflation concerns continuing within developed markets, resulting in downward movements in both equities and bonds. We predict that rates are now close to their peak and are likely to remain at this higher level for longer than expected. This has resulted in a drop in markets.
The chart below shows the returns of major indices over the quarter. As we can see there was a volatile journey experienced in all areas of the global market.
Volatility returns to the US
The summer was a bit of a rollercoaster for US stocks and bonds, and it left many investors scratching their heads. Despite the US Federal Reserve’s efforts to cool things down with higher interest rates, the economy continued to surprise by growing more than expected. This growth means lowered interest rates are likely to be further away than originally expected. This negative sentiment resulted in major US stock markets end at near zero growth.
The Federal Reserve took a break from raising interest rates in September but hinted that they may revisit later in the year and keep rates high. This didn’t sit well with the global markets, especially with commodity prices on the rise, which meant that inflation was here to stay. At the same time, the Fed members are contemplating fewer rate cuts next year, causing Treasury yields to spike which also resulted in volatility to remain in global markets.
Due to ballooning US government debt, in August, Fitch, the US based credit ratings agency, downgraded the US, raising concerns about the country’s finances for the next three years. These lower ratings result in higher yields, increasing the cost of borrowing; these higher borrowing costs didn’t do any favours for the stock market and put a squeeze on government budgets, leading to even bigger deficits.
During the quarter, we saw the US Consumer Price Index (CPI) for August jump up by 3.7% compared to the previous year, largely because of soaring oil prices. However, if we look at the core CPI, which excludes energy costs, it moved in the right direction; down from 4.3% in August to 4.1% in September. That’s good news for central banks that have been working hard to keep inflation under control with their aggressive rate hikes.
Positivity in the UK
On a brighter note, the UK’s FTSE All share did well, going up by 1.88% during the quarter, thanks to higher prices for oil and commodities and a weaker pound. However, economic growth in the UK remains stagnant in real terms, and continues to be at the mercy of future inflation data.
Light at the end of China’s tunnel
In China, property market concerns kept growing, and the government took measures to support it, such as, lowering mortgage rates for first-time homebuyers and making it easier to buy homes. These actions were meant to boost the economy, which has been slow to recover after the pandemic. Despite all this, market sentiment towards Chinese and Hong Kong stocks turned negative, and both markets experienced downturns during the quarter, albeit ending in positive territory. However, we believe China continues to present attractive long term investment opportunities. Their stocks present more attractive earnings multiples than US ones, and recent market sentiment suggests that the Chinese economy may begin to speed up. It is possible the actions the Chinese government took to boost the economy, like lowering rates and subsidising childcare, haven’t had their full effect yet. Therefore, the possibility remains that we may witness more growth next quarter.
In a nutshell, both the Federal Reserve and the Bank of England raised interest rates quickly, and now central rates are above 5%. The strength of developed economies has surprised everyone, but these high interest rates will continue to put pressure on the economy and cool off inflation. Interest rates will stay high until we see signs the economy and inflation are cooling down. With borrowing costs rising, businesses with strong finances will be more resilient during any economic slowdown. Our core belief of investing in high-quality companies with a track record of growing their earnings will continue. Our investment partners all continue to keep a close eye on global markets as further events unfold.
If you would like further any information, please get in touch with your local financial planner.