Last month proved a mixed bag for global investors. On the one hand, British and European assets had another decent month, buoyed by lower-than-expected energy prices and noticeably lower inflation numbers. This fed into the narrative of a slow-but-sustained recovery, allowing investors to wave goodbye to the woes of last year and look ahead to stable growth ahead. On the other hand, US and emerging market assets had a bad month, after bond yields rose yet again – pushing down equity valuations – and the speed of the Chinese economy reopening disappointed expectations. This led to an overall fall in global equities and bonds, which were down 1.2% and 1.7% respectively in sterling terms. These factors suggest we are far from in the clear. Growth is still slowing but not enough to suppress inflation sufficiently to have central banks relenting from further rounds of rate hikes. We may have climbed out of the depths, but the road ahead is long and arduous. The table below shows February’s returns across major asset classes and regions.
UK-listed large company equities were the brightest of the bunch. The FTSE 100 gained 1.8% in February, following an impressive January rally. Over the first two months of the year, Britain’s benchmark stock index is up 6.2%. This is made more impressive by the fact that the UK was one of the few stock markets to post positive returns in 2022 – despite intense negativity around the domestic economy and the almighty October bond market blowout after the Truss/Kwarteng budget ‘experiment’. In fact, the index broke above the 8,000 mark for the first time in its history toward the end of the month. Those gains have pulled back slightly since, but we are still trading close to all-time highs.
We should not read this directly as a vote of confidence in the British economy. UK large caps are unusually disconnected from the domestic economy, owing to the presence of many big multinationals, particularly in energy. That said, the wider economy has benefitted greatly from the recent fallback in wholesale gas prices. While these have not yet filtered through to households, businesses will already be seeing lower energy bills, giving them some breathing space and preventing the need to jack prices up further. The FTSE 250, pooling a larger group of UK companies with a higher domestic proportion, also climbed in February – albeit by a smaller 0.4%.
The Bank of England (BoE) has already said lower energy prices will be a big help in the fight against inflation. Markets assume it will have to raise rates substantially higher to combat price increases but, on the last day of the month, Governor Andrew Bailey was equivocal: “At this stage, I would caution against suggesting either that we are done with increasing bank rate, or that we will inevitably need to do more”.
The even bigger beneficiary of falling energy prices and the avoidance of blackouts is Europe. European equities were up 0.8% in February, meaning the stock market has gained an impressive 7.7% year-to-date in sterling terms. There were dire expectations for the continent this winter, but warmer weather, energy substitutions and improvements in storage capacity have made for a much brighter picture. It is not just current gas prices which have given relief either: futures prices for next winter have now also moved down substantially. European energy is still much more expensive than it was 18 months ago, but we appear to be through the very worst of the crisis.
Across the Atlantic, energy supplies were never as grave a concern. While that helped the US economy and its capital markets last year, it also means the US has little to gain from energy price reprieve. This is reflected in the fact that the S&P 500 fell 0.8% in February, after already underperforming European stocks in January. Just like last year, the negativity stemmed from bond markets, where both US Treasury yields and corporate spreads (the premium of corporate over government yields) increased.
The US economy remains surprisingly strong, despite talk of an oncoming recession for more than a year now. While pay increases have levelled off and there have been some high-profile layoffs, the labour market remains extremely tight. This means that job cuts are mostly being absorbed by new offers elsewhere, keeping overall unemployment very low. That in turn means consumers still have available income, keeping demand and sentiment strong.
This is not just a US phenomenon. Although the UK & Europe are not as strong as the US, consumers and businesses appear more resilient than expected. Labour markets are also tight here and may be contributing to inflation pressures which remain stubbornly persistent, and are expected to keep the central banks in tightening stances for longer than anticipated at the end of 2022. Last month, this came through in the 1.7% fall in the Global Aggregate Bond Index (hedged into sterling) as yields rose to reflect higher for longer inflation and interest rate expectations.
The other big story of the year has been China’s phantom rebound. In the first few weeks of 2023, expectations were high for the world’s second-largest economy, as it finally emerges from three years of zero-Covid policy. As yet though, the expected strong rebound has been elusive. Last month, global investors apparently decided they had been overly optimistic on Chinese growth, and pulled back the impressive gains that Chinese stocks picked up from December. This led to a 4.9% fall in emerging market equities in sterling terms – while China’s stock market declined 6.8%.
For now, it suffices to say that China being slow off the mark does not mean it will not get going. On the first day of March, for example, Chinese equities jumped again, erasing much of February’s falls, following the report of a decade-high in manufacturing business optimism.
Finally, we note that daily trading volatility declined for bond and equity markets, hitting the lowest levels for the last 12 months by mid-month before rising in the final days. Easing geopolitical and thereby energy price concerns have probably played a part, but while markets have finally digested the bond market upheaval from last year, the last day of the month saw ten-year bond yields rising sharply again. While we cannot expect plain sailing ahead – as US losses last month showed – the already higher yields probably limit further yield rises. This in turn suggests market volatility will be lower, relative to last year.
Asset class returns as at 28th February 2023
The text is taken from The Tatton Weekly and is provided by Tatton Investment Management. The information in this document does not constitute investment advice or a recommendation for any product and investment decisions should not be made on the basis of it.
Tatton is a trading style of Tatton Investment Management Limited, which is authorised and regulated by the Financial Conduct Authority. Financial Services Register number 733471. Tatton Investment Management Limited is registered in England and Wales No. 08219008. Registered address: Paradigm House, Brooke Court, Wilmslow, Cheshire, SK9 3ND.