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Article | 18 October 2023 | Investments
Inflation in the US remains high, signalling to many market participants that Fed interest rates will remain elevated and dashing hopes of substantial rate cuts in 2024. A narrowly avoided US government shutdown, averted at least until mid-November, added to the malaise. The European Central Bank raised rates for the 10th time in 14 months to a record high of 4%, but it signalled this was likely to be its final hike during the current cycle. Elsewhere, data releases in China offered some hope that its economy might be bottoming out. Oil prices rose following the rise of geopolitical tensions in the Middle East, but remain below their recent highs of close to $100 a barrel in late September.
Worn down by the Fed’s ‘higher for longer’ stance, global equities sold off in September, with the MSCI World index returning -4.4%. The S&P 500’s return of -4.9% was its weakest monthly performance so far this year. Energy was the best performing sector, generating double-digit returns, while defensive income sectors like real estate and utilities detracted. European stocks declined, as did those in China, despite that government’s plans to liberalise capital controls in major cities there. Emerging markets outperformed global equities on a relative basis, although they too ended lower, with the strength of the US dollar proving a particular headwind. In contrast, the UK’s FTSE 100 rose in September, helped by its large weighting in energy companies.
Market volatility has increased as the ‘higher for longer’ interest rate narrative from the US Federal Reserve (Fed) weighs on sentiment. This led to lower bond and equity prices for much of September, though this is likely to prove more of a medium term risk. In the near term, markets will continue to focus on the improving inflation outlook and economic resilience in the US. Both of these increase the likelihood of a softer landing for the US economy following the slew of rate rises in the last 18 months.
We remain neutral on equities, but on a relative basis continue to prefer US equities to those in the eurozone. We also like equities in Japan. The yen is trading close to ¥150 vs. the US dollar, a figure that historically has proved a key resistance level and the yen could strengthen, particularly if the Bank of Japan intervenes to support the currency.
Our concerns regarding emerging market equities continue to grow. We will review different ways of investing in the region, in particular separating out the Chinese market which has an oversized impact on the returns for this asset class/region.
Regarding fixed income, we have downgraded emerging market debt as the ‘higher for longer’ backdrop, which bolsters the US dollar, is expected to prove a growing headwind for this asset class. We remain neutral on investment grade credit and high yield bonds. Elsewhere, we maintain our preference for US government bonds over those in the eurozone.
Recent interest rate increases mean that short-term money market rates are at their most attractive levels in a long time. With real yields increasing as inflation eases, this makes cash or money market funds appealing compared to absolute return or similar alternative strategies. As such, we prefer cash over alternatives where portfolios allow.