Our Advisers investment review of the start to 2023
January – A good start to the year
- The start of the quarter was positive for investors. Markets were pricing in the prospects of lower inflation with interest rate rises slowing. Both the UK and Europe avoided falling into recession and the issues arising from higher inflation were starting to reduce. Supply chain inefficiencies continued to reduce, with gas prices falling. This all painted a more positive picture for the global economy than many had predicted moving into the new year.
- Alongside this, China resumed its reopening following the lengthy lockdowns that were in place due to the COVID-19 pandemic. This provided an increase to global consumption, as well as helping to further reduce supply chain issues, which gave a boost to the global economy.
- Gains were made across many asset classes as investors priced in the constructive data releases and the hope that the impending slowdown would be far less severe than first predicted.
February – An increase in volatility
- As we moved through the quarter, risk sentiment started to change in markets. Inflation numbers released showed that costs of goods and services were stickier than first hoped.
- Positive economic data announcements started to spook the markets into thinking that central banks would have to raise interest rates further than what was priced in.
- This led to a rise in bond yields, which fed through to put pressure on asset prices. As the risk-free rate increased, the potential future return for assets would be lower which therefore led to tension in markets.
March – Banking collapse drives sentiment lower
- As we entered March, central banks took a back seat as the global banking sector took centre stage. Many economists (including the central banks themselves) have stated over the past year that the impact of interest rate rises would work with a lagged effect and there could be negative fallout to economies from having to raise interest rates so frequently in such a small amount of time.
- One of these risks emerged during March as Silicon Valley Bank (SVB) in the US went under after a bank run on their deposits. To match the deposits that were leaving on mass, the bank had to sell their collateral bonds at below-par prices. This led to huge losses on the bank’s balance sheet, which forced the bank into filing for liquidation and the US regulators having to step in.
- SVB has now been bought out by another regional bank in the US, with the UK arm of SVB being bought out by HSBC. This, along with other lines of liquidity introduced by central banks and banking regulators, provided some clarity on the matter. This stopped the contagion from becoming too widespread across the sector, however, markets continued to be volatile.
- Following the collapse of SVB, Credit Suisse added to its list of woes when its largest shareholder, the Saudi National Bank, declined to provide any additional capital to Credit Suisse after investors started to get worried about its deposit outflows.
- The risks for the banking sector are far greater when a bank the size of Credit Suisse comes under pressure and so markets again moved very quickly on the news. Investors flooded to safe-haven assets with financial equities and other more cyclcyclical-based investments coming under pressure.
- With the risks to Credit Suisse increasing rapidly, the Swiss banking regulator and central bank worked extremely quickly to facilitate a deal with its rival UBS. They bought the troubled bank for a huge discount whilst also removing certain creditors from the deal that was put together.
- This provided a backstop to contagion risk, especially in European financials which led to a reduction in volatility as we moved toward the end of the quarter.
- Focus then shifted swiftly to the central bank meetings at the end of March to see if the issues in the banking space would reverse their comments from February and stop them from hiking interest rates further. There was an acknowledgment that risks remain in the banking sector, but that contagion was limited. All the central banks continued to focus on inflation as their number one priority. Interest rate hikes were undertaken by the Federal Reserve, Bank of England, and European Central Bank during March.
In summary
Over the quarter, our team has had regular meetings with the managers of the funds we hold, to make sure these funds continue to behave as we expect. We are happy with how the portfolios are currently positioned. The underlying managers, especially within the active space, are utilising the heightened volatility in markets to add to holdings they believe were sold off indiscriminately and should outperform over time.
We have also been talking and identifying opportunities for the future within our portfolios that the recent changing economic backdrop has made more attractive for long-term investors. One such area is increasing our allocation to Emerging Markets (EM). Portfolios been underweight on EM due to the issues in China, the strong US dollar, and the impact that rising interest rates have on EM economies. This may prove to be an opportunity in the future.
- While inflation data continues to make for gruesome reading in the UK, a staunch optimism remains that there will be significant falls before the year is out.
- Chancellor Jeremy Hunt suggested in his Budget announcement that inflation will fall to just 2.9% by the end of 2023 and while this may seem optimistic, we are seeing notable falls across the US and Eurozone already. Positive noises were also heard emanating from the BoE, which upgraded its outlook for the UK economy, and predicted we would not see a technical recession, categorised by two consecutive quarters of negative GDP growth, this year.
With conflicting forces at play, markets look set to continue their nervous mood. As economic data releases are yet to paint a consistent picture of the pathway for the rest of the year, we expect this mood to continue. Volatility will undoubtedly remain a key theme, but we recognise that signs of cautious optimism are emerging.