May into June, so far, has been a good month for equities in general, with Latin American equities leading the way at circa 9.86%. Emerging markets, Japan and the US, also in positive territory for the period.
Fixed income continued to face headwinds as yields, particularly in UK Gilts, pushed upwards through May, leaving a drawdown of circa 4.5%. Other fixed income assets performed poorly too, but not by the same degree. High yield is the one area that has persistently defied gravity this year and remains in positive territory for 2023 as a whole (+3.83%) but was flat through May. Whilst we have some exposure to high yield, we remain more sceptical on the poorer rated assets, considering the attractive yield to be found elsewhere and the ongoing refinancing risk in the face of higher rates.
During the past month, it has been the world’s biggest central banks that have dominated headlines. However, from hawkish pauses to rate hikes and dovish tones, they have all taken very different stances on monetary policy.
Central banks
Centre stage was the Fed meeting which ended up giving a somewhat confused message, more akin to what we associate with a central bank rather closer to home. The Fed left rates unchanged at 5-5.25%, as expected. Instead, the surprise was that, despite deciding to pause this month, it is now forecasting two more rate hikes later this year, rather than just one as previously.
There was no such mixed message from the ECB, as it surprised markets by raising rates another 0.25% to 3.5% and said a further 0.25% hike in July was very likely.
In Japan, where inflation is above target, the central bank has left its ultra-loose policy unchanged.
The BOE met yesterday, shocking some economists and investors by raising interest rates half a percentage point to 5% – the highest level since 2008. The UK has higher inflation than any other country in the G7 and is expected to see its interest rates peak higher than other major economies.
Despite the negative headlines, we must remember that a country’s economy and stock market are separate entities, and we remain optimistic for many UK equities from here. The argument for the UK is primarily based on its cheapness relative to its history and other regions. Its P/E ratio is only 10.3x, 25% cheaper than its average over the past 30 years and 35% lower than the rest of the world. Valuations may be a poor guide to short-term market moves but are a good indicator of long-term return potential. There is always a counter-argument that a country is cheap for a reason, but then that difference of opinion is what brings the opportunities.
China
In China, the situation is very different. The question here is not how much policy will be tightened but how much it will be relaxed to support the post-covid recovery. The recent economic activity numbers for May all disappointed the markets, and no doubt the government as well, but since then, the Chinese central bank has made numerous interest rate cuts and introduced new stimulus measures.
The other positive development was US Secretary of State Blinken’s visit to China, which may signal some easing in US-China tensions.
All this has led to China being one of the best-performing major equity markets in June despite having a relatively dismal May, though once again, this strength has faded for now. Still, we continue to believe it has more significant upside potential than its geopolitical rival.
US
US equities did make some headlines during the past month too, as the S&P 500, the pre-eminent US equity index, is now up 7% from last October in sterling terms and over 23% for US investors. A gain of over 20% is often touted as the traditional marker of a bull market, however, it is a little early to get the champagne out. The rally has been concentrated in a handful of mega-cap technology stocks, and the recovery in the rest of the US market has been much more muted. Furthermore, the major uncertainties facing investors have yet really to be resolved one way or the other. Chief amongst these is whether or not the US will end up in recession.
The other point is that the recovery in US stocks, at least as far as UK investors are concerned, has been considerably smaller because of the recovery in the pound from its low at the time of the infamous mini-budget.
The recovery in US equities looks somewhat overdone to us, and we believe other regions have significantly more upside in the future.
Japan
Finally, Japan has had a good run recently and looks more attractive. Valuations are also supportive here, but more importantly, the scourge of deflation may finally have been vanquished. Japanese companies, encouraged by the government, at long last seem to be putting more emphasis on delivering value to their shareholders.
We will be delving further into our views on Japan and its potential benefits for investors in our monthly ‘Investment Team Insight’ due to be released in our newsletter ‘The Inside Look’, next week.
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