Investment Update: December 2023

INVESTMENT UPDATE DECEMBER

Overview

Most major markets enjoyed an extremely buoyant month in November, as bond yields retreated from their highs amid growing speculation about the direction of interest rates. This was supported by increasing evidence that central banks’ efforts to subdue inflation are having a positive impact. Returns from the US were dampened for sterling investors as the dollar weakened versus the pound (the value of the pound and returns from dollar assets move inversely to each other). This in turn dampened relative returns from the FTSE 100, where a high level of company earnings are earned overseas, so a stronger pound reduces those earnings in sterling terms. However, the heavily discounted FTSE 250, representing the next largest 250 companies, enjoyed one of its best returns for many months at over 7%. This combination of rising equity markets and bond prices led to a welcome boost for portfolio returns.

Global Inflation Rates

Source: Refinitiv

US

The rally in the US was sparked by both softer inflation and economic data. Of particular note was the widening of the rally beyond the oft mentioned ‘Magnificent 7’ stocks, into value stocks and mid/small sized companies. The evenly weighted S&P500, which as the name suggests weights every stock at the same level, matched the company size weighted equivalent, further demonstrating the breadth of the underlying market moves.

The Consumer Price Index (CPI) came in at 4%, down from 4.1% and was accompanied by some positive comments from members of the US Federal Reserve (Fed), suggesting that inflation could well get back to their 2% target and some even suggesting cuts mid-2024, when markets previously were looking to the end of next year as the most likely. On the wider economic front, the Purchasing Managers Index (PMI) continued to indicate a slowdown in manufacturing with a reading of 46.7 (sub 50 indicates a slowdown) and payroll increases slowed down, pushing the unemployment rate up to 3.9%, a level last seen at the start of 2022. A strong labour market is often cited as a key underlying inflation indicator to the Fed, so this weaker picture helped to further fuel speculation over interest rates. A knock-on effect from this was a weakening of the dollar index, which represents the value of the US dollar versus a basket of currencies, falling by 3% since October.

Europe

Inflation in the Eurozone continued to decline at a faster rate than anticipated, with German CPI falling to 2.3%. There the economy continues to struggle in recession, as manufacturing slows down in response to a falloff in demand, whilst German corporate investment declines correspondingly. The government there was also dealt a blow to its spending plans when its constitutional Court ordered the cancellation of 60 bn euros of green and industrial projects, as it would break German self-imposed debt limits. Countries such as Sweden have also recently joined the list of countries entering recession and it is looking highly likely that the European Central Bank will be the first among western central banks to cut interest rates – a fact which might help explain the strong performance of the Euro Stoxx index in November.

UK

UK bond yields declined swiftly from their highs, which led to some good returns from gilts (bond prices move inversely to yields) and the ten-year rate now sits just above 4%, having been closer to 5% in preceding months. The positive impact of this was limited with regards to the broader UK equity index, but as previously reported, mid-sized company shares rallied significantly. However, the UK still grapples with a far more stubborn level of inflation that other economies and the Bank of England has been quick to restate the need to keep interest rates elevated in order to achieve its stated target of 2%. Economic growth points increasingly to stagflation, although there was a boost to the UK’s PMI, with a reading of over 50, the first expansion in output since July.

Japan

Japan continues to be one of the standout major stock markets so far this year. The Nikkei index was up over 6% in sterling terms in November, despite a larger than expected contraction in the economy, but this move was likely aided by a weaker dollar. GDP was a negative 2.1% in the third quarter, led by a fall in domestic consumption as the Yen remains weak and consumers cope with a higher cost of living due to the pickup in inflation. However, there remains the prospect of the relaxing of the Bank of Japan’s yield curve control* and its potential to both strengthen the yen and make domestic bond markets more attractive to Japanese investors.

*Yield curve control (YCC) – for a number of years the Bank of Japan have been limiting the maximum yield available on their 10-year bonds by buying bonds in the market, thus limiting the return available.

Asia and Emerging Markets

The Chinese economy continues to struggle with the slowdown in domestic consumption and the debt overhang from the heavily deflated property market, with some of the largest property companies trying to refinance debt and consumers paying down mortgages rather than spending. However, elsewhere in Asia, markets were extremely buoyant with the weaker dollar probably contributing to this, as this reduces dollar-based debt repayments for companies. Latin American markets were the best performing in local currency terms, with indices generating double digit returns. The highlight from the region was the performance of the Argentinian stock market, up over 40% in November, as investors reacted positively to the election of the right-wing politician Javier Milei as President. However, given how few seats his party has in the country’s senate and congress, this could make some of his more radical ideas difficult to implement in practice, so whether the rally can be sustained remains to be seen.

Outlook

Portfolios still maintain a small exposure to money market funds, particularly in lower risk strategies where the reasonable level of yield supports the zero duration (bond price sensitivity to interest rate movements) profile. However, this is likely to be deployed into higher duration securities as we see further visibility emerging on the interest rate front and the positive opportunities here are plain to see. The wider, global approach to equity asset allocation has been rewarded following this month’s reduced reliance on the previously narrow opportunity set of US and UK large caps to generate positive returns and any further weakening of the dollar will be supportive moving forward. However, US dollar asset exposure remains partially hedged as a consequence.

Rockhold Asset Management, with contribution from Alpha Beta Partners and Marlborough, December 2023

Your Capital is at risk. Past performance is not a reliable indicator of future results. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. Your capital is at risk and the value of investments, as well as the income from them, can go down as well as up and you may not recover the amount of your original investment.