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Equities have so far enjoyed mixed success – improvement for the rest of the year remains an imponderable!
David Buik, market commentator
The first half of 2023 has been a very challenging period for global equities. Economists and fund managers have certainly had their work cut out. An unparalleled energy crisis, recently exacerbated by an unholy alliance between Russia and Saudi Arabia over oil production, coupled with a dangerously escalating war in Ukraine, supply chain issues and inflation, which remains stubbornly high, have dominated the investment agenda.
Inflation has been rampant across the spectrum, especially in the UK. It reached 11.1% and is now down to 7,9%, whereas in Europe it reached 9.2% in 2022 and is expected to fall to 5.5% in June 2023. Why the differential between UK and the EU? – It is mainly energy costs that have been at a lower level in the EU, with some countries, such as Germany, happy to buy Russian oil last year, whereas the UK refused to do so, and its parlous energy crisis has been exacerbated by a lack of an overall energy policy. Inflation in the US has fallen from 4% to 3% in June 2023, thanks to it being energy self-sufficient. Putin, despite the Wagner mutiny, remains precariously in charge. A relatively united NATO will hopefully prove to be a constructive adversary. However, peace in our time seems a long way off. It also should not be forgotten that the world’s economies are still struggling to recover from the global pandemic of 2020/21.
Inflation has been rampant for nearly two years. Consistent increases in interest rates have been the main tool to fight inflation. The FED has led the charge implementing increases ten times to 5.0%-5.25%. The MPC have implemented thirteen increases to 5.0% but were slow out of the blocks in making measurable increases. As inflation remains stubborn, a further 0.25% increase to 5.25% is expected on 3rd August 2023. In essence, interest rates are quite a blunt though effective instrument for Central Banks to stamp on inflation. Conversely, the country should have been weaned off quantitative easing months ago, if not years ago. Quantitative easing was very necessary fifteen years ago in response to the banking crisis, but during his tenure as Governor, Mark Carney should have trimmed back on the Bank’s bond buying activity, as well as implementing a gradual increase in a commercial rate structure. The banking crisis of 2008/9 and the pandemic have seen quantitative easing reach an eye-watering level of £895 billion!
Against that economic and geopolitical background global equities have experienced mixed levels of achievement. The NASDAQ, the S&P500 and the Nikkei 225 have acquitted themselves with aplomb. The DAX and CAC, which only have thirty and forty constituent stocks, have posted reasonable gains, but they are hardly a barometer of the German and French economies. It is interesting to note that the main gainers in Germany have been tech – Infineon +15% and SAP +16% and in France it has been the similar – ST Micro +22%, though LVMH and L’Oreal are both up 10% this year.
The normally ebullient Hang Seng has been caught in a vortex of Chinese political uncertainty and the Shanghai Composite illustrates the underperformance of China’s economic recovery process by their high standards, post the pandemic. Set out below are the closing levels year to date of the main global indices on Friday 14th July 2023 - FTSE -1.58%, FTSE 250 -2.97%, DAX +14.47%, CAC40 +11.83%, DJIA +4.14%, S&P500 +17.82%, NASDAQ+35.88%, NIKKEI +25.95%, HANG SENG -3.63%, SHANGHAI +3.89%
Apple (+52%), Amazon (+56%), Tesla (+160%), Alphabet (+41%), Nvidia (+217%), Meta (+147%), Microsoft (+44%) and Spotify (+110%) have undoubtedly been the fulcrum for gains generated on the US stock exchanges so far this year, with the Nasdaq dominating proceedings. Having experienced reverses in 2022, techs are very much the flavour of the month. It seems worryingly unhealthy that eight stocks are responsible for the momentum behind the Nasdaq’s progress this year and for that matter the success of the NYSE. US banks have been off colour since SVB, Signature Bank and First Republic were exposed for balance sheet and liquidity weaknesses, largely caused by exposure to bond market prices, which had fallen rapidly (rising yields). Recent increases in interest rates have started to trigger a modest recovery in this sector. The unconnected Credit Suisse debacle did not help the European banking sector’s cause either. Unsurprisingly pandemic vaccine stocks such as Pfizer (-28%) and Moderna (-31%) have been friendless in the ring this year, after a terrific run on the rails in the previous two years!
As for the UK, telecoms, mining, utilities, and banks (HSBC and Standard Chartered Bank excluded) have been out of favour this year, as have BP and Shell in a more modest way, having been much in demand in 2022. Last year, the defence sector in the US and in the UK (BAE Systems) blazed the trail. Though the European defence sector has continued to make healthy gains, its US counterparts have surrendered value, especially Northrop Grumman (-16%) and General Dynamics (13%).
Last year house builders were decent ‘Arfur Daleys’. This year they have fallen away, due to the mortgage crisis and the cost of borrowing. Since Brexit, international investors have had a negative take on the UK. Funds have tended to head elsewhere rather than find suitable havens on this wonderful ‘Sceptred Isle.’ The Government needs to illustrate the benefits of Brexit considerably better than it has to date. This would help immeasurably to restore confidence in investors. Assets look so cheap here in the UK. Hence it attracts many corporate raiders. The performance of the FTSE 100 and the 250 has been dispiriting to date. The Government needs to provide improved stimulation for business rather than keep beating the drum of financial prudence and draconian taxation. On a positive note, some retail brands have performed resolutely this year – M&S +53%, NEXT +16% AO World +59%, Sainsbury’s +21% and JD Sports +17%. Unsurprisingly, airlines have also risen like the ‘phoenix from the ashes.’ – IAG +20%, Wizz Air +48% with easyJet and Ryanair both +44% so far this year. With retail playing such a strong hand in US GDP, it is interesting to note these contributions – Abercrombie & Fitch +47.92%, Nordstrom +20.75% and Urban Outfitters +42.62%
Japan’s Nikkei has also been a star performer so far this year. It is only about six thousand short of the 38,957 it reached during the asset bubble of 1989. The Rugby World Cup of 2019 and the Olympics of 2020 looked as if they would provide a great springboard for the revival of Japanese equities. However, the pandemic certainly helped in temporarily ‘bursting that balloon.’ Improved corporate governance and greater clarity over ownership of companies has contributed to the NIKKEI’s success this year.
IPOs in the US have been parsimonious by its high standards and smaller in size than usual – just 79 to date down 36% on last year. However, when conditions improve, ARM Holdings, Flutter and CRH will take their chance in New York rather than in London. IPOs in London have been negligible in size and are down 30%. Companies are frustratingly valued about 30% lower in London on a pari-passu basis to ‘The Street of Dreams.’ Last week’s Mansion House speech by Chancellor Hunt offered a glimmer of hope, with pensions funds being encouraged to invest £50 billion in UK SMEs, including those quoted on a growth market such as Aquis Stock Exchange or AIM, and hopefully more accommodating regulation will help to rejuvenate the UK IPO market.
The Dollar has been very strong all year thanks to the aggressive stance adopted by the FED and these interest rates hikes have seen bond yields rise sharply. Consequently, government bonds have taken funds away from equities as yields of 4% to 5% are more attractive. Crypto Currencies are proving very popular, despite a lack of Central bank regulation, which hopefully will be rectified before too long. Bitcoin, as an example has seen its price rally from $13,100 to $31,200 – up 138% - Prenez garde! This product is for those who have been well advised.
What of the rest of the year? Much depends how fast inflation falls and how quickly the cost of borrowing eases. Recession still stares many countries in the face. The US looks like it will avoid it, with inflation ‘back on the bridle.’ However, Europe and the UK remain vulnerable to a modest recession. So, stock picking will be a pre-requisite.