What a difference a few weeks make. In a complete turnaround from October, November was all smiles for international investors. Capital market returns were positive across virtually all regions, and in many cases massively so. As autumn ended, fears over prolonged inflation and interest rates staying higher for longer seemed to dwindle with the daylight. A perceived softening from central banks preceded a significant rally in global bond prices. The sinking of bond yields – the inverse of prices – lowered the so-called ‘risk-free’ rate of return and made stocks look much more attractive by comparison. The table below shows November’s returns across key regions and asset classes.
Nowhere were the changing tides more keenly felt than Europe, whose benchmark stock index gained a mightily impressive 6.2% through the month in sterling terms. Even better for Europeans was the news that consumer price inflation for the Eurozone fell to 2.4% year-on-year in November, down from 2.9% in October and the lowest reading since July 2021. The continent has been hit the hardest by energy price spikes over the last two years, but that sensitivity is now coming good as energy prices continue to fall.
Falling input costs – exemplified by November’s 7.6% fall in commodity prices – put pressure on the European Central Bank (ECB) to relax its monetary policy, but Governor Christine Lagarde has been steadfast in her commitment to the ‘higher for longer’ mantra. Markets are convinced she will relent, though, with many bond traders now betting on a European rate cut as soon as Q2 next year. Implied market expectations put rates nearly 1.5 percentage points lower than the current 4% level by the end of 2024. The ECB will meet next week, and policymakers are expected to downgrade Europe’s growth outlook after much worse than expected data from Germany. Lagarde’s resolve will be sorely tested.
A big part of investor positivity towards Europe has been because European assets are so sensitive to expectations for the global economic cycle – which some may believe could be turning thanks to lower inflation and expected monetary easing. Small- and mid-cap businesses – much more sensitive to economic and financial conditions – did well in November. Emerging Markets (EM), which so often rise and fall with the global economic tides, also did well after what has been a challenging year. Incredibly, EM equities are now up year-to-date in sterling terms.
The only exception for EMs, and indeed for major asset markets in general, was China. Chinese equities endured yet another down month, for reasons we cover in a separate article, but two things are worth noting here. First, even with EMs’ largest component suffering a setback, the headline EM index is up on a monthly, quarterly and year-to-date basis, showing the wider resilience of EMs. Second, and perhaps more importantly, economic weakness in China is acting as a deflationary force for the rest of the world, as the country ships out exports at lower prices. This is a serious benefit at the moment, allowing central bankers room to loosen policies.
The bond market rally was the biggest factor underlying equity growth, at least in the first half of November. The US Federal Reserve (Fed) left rates unchanged at its November meeting, but the weakness of US and global inflation data since then has convinced markets that even the Fed – overseeing by far the strongest internal economy in the developed world – will look to cut rates by mid-2024. Bond yields fell and equity valuations adjusted, pushing up rate-sensitive assets in particular. This can be seen in the stellar performance of large US tech companies.
From mid-month, though, the mood seemed to shift. Markets were still positive, but now dared to envisage not only lower interest rates, but stronger growth too. That meant outperformance for near-term growth assets like small-cap companies, which began outperforming the US mega-caps. Underlying all of this was the belief that the proverbial ‘soft landing’ – a turning of the economic cycle without any substantial downturn – could actually be within reach.
This is because, despite all the doom and gloom this year over extremely challenging financial and economic conditions, at no point have we seen signs of systemic credit stress. The banking crisis in March was managed thanks to Fed liquidity and deposit guarantees. Now, monetary policy is shifting and a high level of defaults have still not come. This has allowed credit spreads (the difference between corporate and government borrowing rates) to fall significantly, increasing hopes of growth next year.
Where growth expectations have not come through, unfortunately, is in the UK. UK bond yields led the way down earlier in the month, but shifting economic expectations did not follow through, perhaps explaining the FTSE 100’s relatively mild 2.3% return. The situation was not helped by Britain’s policymakers, who together suggested ‘higher for longer’ might be even stronger in the UK than elsewhere. The Bank of England (BoE) continues to shout down any suggestion that rates can be cut next year – though we have our doubts about its resolve.
The BoE is perhaps put in a bind by the Treasury though, after Chancellor Jeremy Hunt used his Autumn Statement to signal some mild tax giveaways. While these are unlikely to substantially increase growth, they do eat into the fiscal headroom that had previously bolstered government finances. With that headroom gone, there is a continued feeling that UK inflation – and hence, higher interest rates – are not over. UK bonds and subsequently equities fell behind their peers.
Overall, rainy November was much less bleak than had been feared. No-news days at the two biggest central banks – the Fed and the ECB – was welcomed with open arms. For the global economy, perhaps the most important factor heading into the year-end is that the US dollar ceased rising. Having been strengthening for so long, a somehow softer dollar gives the cyclical recovery more space, and those borrowing in USD (predominantly EMs) room to breathe.
Asset returns as at 30th November 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.
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