Q3 2023 Review; Q4 Outlook

Market & Macro Review for Q3 2023

The table below sets out performance to end of Q3 2023, by various assetclasses and styles.

The year, so far, has fluctuated between “risk-on” and “risk-off” with Q3 starting to see markets become flaky. Developed Market equities declined over the latest quarter but still left investors with a return of almost 12%. Value equities held firm at almost 3% on the year. The star performer has been growth which, despite suffering an almost -5% decline in Q3, is up a strong +21% on the year. It hasn’t totally recovered its 2022 loss of -29% but, investors comparing this on a back-to-back basis will be feeling relieved. What should not be underestimated is how the rise in markets – especially US equities – has been dominated by technology. The latter itself has come to be associated with the “famous seven” technology stocks.

The table below shows performance by world stock markets:

Japanese equities were the single best performer – over both the quarter and YTD (Year-To-Date) in local currency terms. This is despite a weak and weakening Yen which feeds into rising inflation. Driving local markets are rising wages, an acutely tight labour market and more companies raising and passing through prices to consumers to offset rising costs. The combination of this with still loose monetary policy has been a boon to local, Japanese markets. The UK market did well over Q3 aided by the rally in energy prices and the high energy component in local indices. Outside of these, it’s a very different picture with all other regions displaying negative returns.

Given the rising volatility and heightened interest rates, how have Fixed Income markets performed? Simply put: stressed!

Global Index-Linked (IL) has taken quite a knock over Q3 2023, YTD 2023 and 2022. You would have thought there was no inflation scare at all! European and US High Yield (HY) has performed well and are neck-and-neck on a YTD basis. The search for yield is a big driver here given the scope for spread (risk) compression. By contrast, Investment Grade (IG) is flat on the year while falling on the Quarter. This is more of a rotation effect.

RE: Outlook for the remainder of 2023

Q4 is already off to a stormy start in markets driven by the following factors:

1. Uncertainty over interest rates: economies are still managing to hold up reasonably well helped by buoyant consumers. The expectation is consumers will eventually run out of steam but, so far, there hasn’t really been any signs of that. Investors are beginning to question the extent & pace to which rates will come down.There is huge disagreement amongst Central Bankers who are now pushing back on their estimates of rate cuts well into next year.
2. Inflation outlook:despite reasonable declines in inflation globally, recent rallies in energy prices are perceived to work their way back into the inflation system. We are seeing early signs of that in the US where the latest headline inflation print showed a rise. Invariably, rising energy prices have a way of working their wayback into the rest of the inflation spectrum.
3. Demographics, Geopolitics, Technicals: All of these are other factors behind interest rates. Reducing money supply leads to an increase in the cost of money (higher yields); funding deficits (short or longer duration issuance) results in higher yields.Geopolitical tensions increase risk premia (higher yields/spreads). At the time of writing, we are witnessing a major flare-up in the Israeli/Gaza situation. The immediate impact was to send oil prices soaring – this is quasi-inflationary and will definitely have a pass-through effect. How persistent it remains will be entirely down to (1) Israel’s response and (2) OPEC’s response.

The upshot is all the above keeps volatility elevated which, in turn, puts downward pressure on listed equities and listed bonds. Public securities are all exposed to market gyrations regardless of how good their fundamentals are. At this stage, we do not see this as a start of a recessionary downturn but it could well be the beginnings of a bear market downturn. If so, the latter will present an excellent entry point and resurgence by markets. In this regard, the portfolios have been designed with (1) short-duration fixed income allocations which capture good yield and, in the event that rates are lowered, capital appreciation and (2) allocations to quality companies with good earnings power.

As always, currency (FX) movements play their part. Once risk-off sentiment kicked in, the US$ began to strengthen. For September alone, the US$ gained nearly +4% vs GBP, +2.5% vs Yen and +2.5% vs Euro. Prior to that, the US$ Trade-weighted Index was selling off.

You will be aware the Model Portfolios were restructured just recently with a specific outlook in mind which we believe will last for a good 12 to 18 months. Part of this is focused around growth (GDP) steadily picking up while rates slowly approach their peak. Elevated for longer remains our base case scenario for interest rates – and this is becoming evident from the way in which rate cut estimates are being pushed back into mid/late 2024.