Investment
Comment
28th April 2023
What's going on?
In the week that Ed Sheeran is in court accused of copying the Marvin Gaye classic “Let’s Get it On”, investors are more likely to ask the question from another Gaye classic, “What’s Going On?”
Over recent months, investors have been focused on the path of inflation and economic growth and what that means for interest rates. There have been positive signs that inflation has peaked leading to increased optimism that interest rates (at least in the US) are approaching a peak and will be cut later in the year supporting markets. Every economic data release is viewed for consistency with that narrative and recent weeks have seen conflicting signs.
Yesterday saw the release of US GDP for the first quarter. US economic growth slowed in the first quarter by more than expected, rising 1.1% (annualised year on year) as tepid business investment and a pullback in inventories offset a strong pickup in consumer spending. While there is clear evidence that the economy is slowing under the weight of interest rate hikes and elevated inflation consumer spending remains robust, supported by pandemic savings and a resilient jobs market. This is driving persistent inflation, particularly in the service sector. With the GDP release, also comes the US Federal Reserve’s preferred inflation metric, “Personal Consumer Expenditures price index” (PCE), which was higher than expectations and leaves the Fed on track to raise interest rates again when they meet next week. However, with the economy expected to slow further in Q2 and continued challenges in the US regional banking sector, which is impacting lending to the economy, this is still expected to be the last increase of the cycle. Although, we would caveat that expectations can change rapidly in an uncertain environment.
Tech back on top
There have been significant divergences in market performance this year with Technology stocks significantly outperforming and Banks underperforming amidst a mini banking crisis that saw the demise of SVB and Signature in the US and the forced takeover of Credit Suisse by UBS. Technology stocks outperformance seems likely to have been driven by a number of factors: sector rotation after their sharp falls in 2022, the expectation that interest rates will fall should benefit growth stocks, improved market liquidity, and, for the major stocks, a perception that they are less sensitive to more challenging economic conditions.
We are now in the midst of the first quarter earnings season and, as it plays out, we will learn whether this outperformance is justified by strong operating performance. So far this seems to be the case with better-than-expected results from Alphabet (Google), Meta (Facebook) and Microsoft lending support.
Meanwhile, banking results have given us an insight into the challenges facing the US regional banks. First Republic Bank, one of the regional banks caught up in the banking turmoil after SVB’s collapse earlier in the year, was in focus as shares plummeted following results revealing that deposits fell by $100bn. The embattled bank is seeking to seeking to divest $50-100bn of mortgages and securities to clean up its balance sheet but is likely to need significant support to survive, almost certainly through a rescue plan facilitated by the US government.
Such challenges for a lender always throw up concern but despite the travails of First Republic we would note that banks are generally in a healthy position, supported by solid interest margins and with strong capital positions. While there are likely to be issues in a small number of institutions that need to be resolved, we do not believe that there is a systemic crisis. However, it does seem likely that this will lead to a tightening of lending standards across smaller regional banks, which will feed into the broad tightening of financial conditions. This has implications for economic growth. Recessionary concerns are why we remain defensively positioned in portfolios.
No change…for now
We believe that one of the main drivers of market returns this year has been increased liquidity provided by central banks, primarily the US Federal Reserve, in support of the banking system following the collapse of SVB and others, but also from the Bank of Japan. Whereas central banks in most of the developed world have been actively tightening policy in an attempt to bring down inflation, for many years the goal of Japanese policy has been to increase inflation in an economy where deflation has been the primary concern. To this end the Bank of Japan has pursued a policy of negative interest rates and ‘yield curve control’ (that is actively buying bonds to maintain bond yields at a set level) with the aim of encouraging lending in the economy to support growth. There has been much speculation that this policy will end following the departure of Governor Haruhiko Kuroda, who presided over nearly a decade of ultra-loose monetary policy and with core inflation now running at over 4% year on year.
Overnight the Bank of Japan has concluded its first meeting under new Governor Kazuo Ueda, with the committee agreeing unanimously to keep interest rates unchanged at -0.1%. The bank’s ‘yield curve control’ policy was also left unchanged although they did tweak forward guidance slightly, removing the phrase that the bank expected ‘short- and long-term policy interest rates to remain at their present or lower levels.’
Bond markets came into this meeting wary of tightening policy through changes to the policy rate or the yield curve control mechanism, therefore no change has been interpreted positively by investors. Japanese government bond yields and the Japanese Yen have both fallen as a response and this has helped equity gains across Asian indices.
While our exposure to Japanese markets in portfolios is relatively small a tightening in policy would likely have broader ramifications globally through a reduction in global liquidity.
Gareth Thomas
Head of Investment Management
All expressions of opinion reflect the judgment of Artorius at 28th April 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
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