Investment Update – Summer 2023

US and Japanese equities continued to lead the charge in the second quarter of the year up 7.1% and 9.4% respectively, versus a further fall in value of 5% for the broad bond sector. For UK investors, American equity gains translated into a rise of just 4.7% and a small loss for Japanese equities due to rising strength of Sterling. Rising UK interest rates relative to the US and Japan led to a broad strengthening of the pound versus a basket of currencies but in particular the Yen which has collapsed. Weakness in the Japanese Yen has been most pronounced and influenced heavily by their much looser monetary policy than elsewhere in the world. Japan is known for grappling with deflation not rising prices so they have not had the same need to raise interest rates as much.

New heights

With exports being an important element of GDP, Japanese equities have enjoyed a rapid ascent to market heights not seen since the 1990s but for investors outside of the region much of those gains have been offset by the weaker Yen.

After enjoying one of their strongest runs, European equities have paused since our last update in May, not rising or falling, with Germany ‘technically’ in recession. On the other hand, the UK disappointed with shares getting cheaper still, falling almost 4% as net debt surpassed 100% of GDP for the first time since 1961. Emerging markets posted a gain of 3% in local currency.

Last legs?

In our last seasonal update we questioned the sustainability of the equity recovery and clearly the UK has faltered but in global terms markets have continued to make good progress. UK inflation is proving stubborn and while headline rates are coming down gradually they are still way off target and core inflation rates not budging at around 6.50%. Unsurprisingly, gilt yields, which we felt had prematurely softened, headed upwards once again globally but more so in the UK. Guidance released by the Bank of England that interest rates are also likely to remain high for some time did nothing for investor sentiment.

A range of healthy earnings updates from US firms continued to provide support and as mentioned before the US consumer remains quite sheltered from monetary tightening with homeowners mostly holding 30 year fixed rate mortgages. The majority of these are of course at a fraction of the cost of todays average US mortgage rate of 7.20%! In the UK, the shelter of fixed rate mortgages is gradually fading, a dynamic that will hit consumer spending but one we feel is yet to be fully priced into markets. The US consumer may be last to come under pressure but cracks are appearing, for example first time buyers are vanishing from the residential property market.

Beneath the Bonnet

Headline returns don’t always reveal the full picture, as we have shown with inflation numbers. Stock market returns are the same, on the face of it markets look in ok shape, US earnings have been healthy, employment and growth hasn’t disappointed, economically sensitive leading sectors like transport stocks are performing strongly as is the overall US index (S&P 500). On the other hand, the share price of a particularly key transport stock ‘Maersk’ has been in decline and enormous US spending packages as part of ‘Bidenomics’ will provide some artificial support for stocks. Additionally, a look behind the S&P 500 returns shows that much of the returns this year are being generated by a handful of stocks (seemingly ‘AI’ or artificial intelligence related). The level of concentration in the US stock market (ie the index proportion accounted for by the top 10 stocks) is the most concentrated it has been since 1932 and would not typically be associated with a broad based healthy recovery. Finally, the worlds second largest economy, China, which has historically been a better lead indicator of world economic health is on more shaky ground with the post-COVID recovery stalling. Contradicting indicators exist but enough challenges present for us to maintain caution but not yet with full conviction.

In our last update we noted an improving outlook for cautious investors more specifically due to attractively yielding fixed interest/bond funds which are held in higher proportion in lower risk portfolios. Over the past few months we have seen rising bond yields and rising global equity. It will be difficult for this trend to continue in unison and we believe the greater risks remain to shareholders where risks have increased yet risk premiums are vanishing.

The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.