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Summary Review of February 2023

Date:
Author:
Gill Hutchison
IA Sector:
N/A
Asset Manager:
N/A

After a strong start to the year, equity markets lost momentum in February.  With high inflation proving to be persistent, investors reassessed the prospects for interest rates in response to hawkish comments from central bankers.  Geo-political tensions also weighed upon investor sentiment.  Despite the nervy mood, UK and European equity markets managed to close the month in positive territory, whereas the US and Asian markets were weak.  After a positive start to the year, government bond yields rose sharply, delivering negative total returns to beleaguered investors.  

Backdrop

  • UK politics: The country grappled with the worst strikes since the 1970s with nurses, teachers and ambulance drivers (amongst others) walking out.  First minister of Scotland, Nicola Sturgeon, announced her decision to step down.  In response to the challenges of the Northern Ireland Protocol, a political agreement between the European Commission and the UK government was reached in the form of the Windsor Framework.  Shortages of fresh foods on supermarket shelves highlighted the vulnerabilities of the UK’s food supply chains.
  • UK economics:  There was little cheer on the economic front.  Data showed that the economy stalled in the final quarter of 2022.  Retail sales numbers revealed a fall in volumes and house prices continued to decline from August’s peak level.  The Bank of England added fuel to the inflation debate, arguing that Brexit is playing a part in stoking prices; the Bank also observed that large increases in public sector pay would add to the problem.  Although the annual inflation rate fell in January, it remains elevated at 10.1%.  The labour market remained tight; the unemployment rate was unchanged at 3.7% and data showed that average earnings have risen sharply.
  • Global economics:  In the US, ongoing strength in the labour market and hot inflation data caused investors to reappraise the outlook for interest rates, rattling risk assets.  In the Euro area, core inflation also remained high, and the unemployment rate stood at a record low.  The German economy shrank during the final quarter of 2022, but a fall in gas prices since then has bolstered consumer sentiment and driven hopes that a recession can be avoided.  Japan registered its highest inflation level since 1981.  Chinese data reflected an ongoing recovery in economic activity following the lifting of COVID-19 restrictions.
  • Monetary policy:  The US Federal Reserve raised rates, but by 0.25%, rather than the 0.50% seen in previous meetings.  With the Fed Funds rate in a range of 4.5%-4.75%, borrowing costs are at their highest since 2007.  Policy makers stated that further increases are likely if they are to bring the inflation rate back down to 2%.  Meanwhile, the Bank of England announced another 0.50% hike, taking the base rate to 4.0%.  However, the Bank also stated its belief that inflation has probably peaked and suggested that it might slow the pace of rate increases in the near term.  The European Central Bank followed suit, also raising rates by 0.50%, although this was accompanied by hawkish rhetoric from ECB President Lagarde.
  • Global politics and events:  US-Sino tensions were raised when a high-altitude balloon was shot down off the coast of South Carolina.  Secretary of State, Antony Blinken, cancelled a trip to Beijing in response.  News that the US planned to expand troop presence in Taiwan for training purposes raised the political stakes.  As the war in Ukraine marked its first anniversary, President Biden made a surprise visit to Kyiv and announced a new package of additional weapons supplies.  Meanwhile, China’s top diplomat visited the Kremlin, and China and Russia reaffirmed their close “strategic cooperation”.  A huge earthquake in Turkey and Syria caused untold damage and loss of life.

Equity markets

  • US markets took a turn for the worse as investors recalibrated their expectations for inflation and interest rates.  (For sterling investors, the declines were mitigated to an extent by US dollar strength.)
  • UK and European equity markets proved to be more resilient and were able to close out the month in positive territory. It is interesting to note that some of the smaller European markets have chalked up impressive returns so far this year.
  • It was a particularly tough month for Asian markets, with a strong US dollar and geopolitical tensions dampening risk appetite.
  • Results from the US technology bellwethers showed that the economic slowdown is impacting end demand from electronics through to digital advertising, reminding investors that even the big daddies of the sector are not immune from the economic cycle.  There were also indications from the big retailers that inflation and higher rates are having an impact upon consumer behaviour.
  • Value indices tended to trail growth indices, although style themes were not dominant this month.  Across markets, it was also a somewhat mixed picture at the sector level.  Retailing, real estate and basic materials were weaker areas, while bank share prices (notably those in the UK and Europe) continued to respond positively to the rising rate backdrop.

Bond markets

  • It was a poor month for sovereign bond investors as the reality of sustained higher inflation and the consequences for interest rates roiled markets.  In particular, longer maturity bonds registered steep price declines.
  • Credit markets were also under pressure.  With less interest rate sensitivity, high yield bonds outperformed investment grade bonds.

Commodity and currency markets

  • There were widespread declines in commodities, with weaker prices seen in the oil, gas, metal and agricultural goods markets.
  • The US dollar strengthened as investors priced in the prospect of further hikes from the US Federal Reserve.
  • Cryptocurrencies continued to recover, shaking off concerns about a US regulatory clampdown.
  • Gold weakened, with the stronger dollar and higher real yields depressing the price.

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