MARKETS IN A NUTSHELL — AUGUST 2023
After July’s rallies, global equity and bond markets took a U-turn in August. Developed economies find themselves in a tug-of-war between growth and inflation. In the US, upbeat economic data and hawkish comments from US Federal Reserve Chair Jerome Powell at the Jackson Hole Symposium have put expectations of early Fed rate cuts for next year in question.
With the US economy remaining hotter than most investors expected, the Fed is now forecast to hold rates higher for longer into 2024 to curb inflation, provided economic growth sustains its moderate pace. US equities fell, but outperformed UK and European bourses, which are burdened by persistently fragile economies and higher inflation.
Despite the good economic news, rating agency Fitch Ratings lowered the US foreign-currency default rating one notch to AA+ in early August. Fitch cited unsustainable debt and deficit trajectories and growing political dysfunction (eloquently labelled as an ‘erosion of governance’). The announcement hardly moved yields at the time. But yields on longer term US Treasuries later soared on debt burden worries, with 10 and 30-year bond yields hitting their highest levels since 2007 and 2011 respectively.
Falling bond prices in August have left US bond investors staring at losses over the year-to-date — after enduring double-digit declines in 2022. Growing US government debt issuance is exacerbating the upward pressure on yields, after the $2.5 trillion increase in the US debt ceiling earlier in the year paved the way for further aggressive fiscal spending.
Emerging market shares fell the most, with poor Chinese economic data weighing heavily on Asian bourses. After a crackdown on excessive leverage that sent the once-booming Chinese property market into a slump, Chinese authorities have intensified efforts to stimulate the economy. These measures include lowering the one-year, medium-term lending facility rate, cutting transaction taxes on share purchases, lowering reserve requirements, as well as reducing down payment and mortgage rate requirements for homebuyers.
Negative country sentiment overshadowed an upbeat start to the Chinese tech earnings season. Tech giants Alibaba, Tencent and JD.Com — all long-term investments in the Foord global funds — reported robust earnings growth, but were among the biggest detractors in the portfolios in August. We are not deterred: companies that consistently generate value through innovation, strong management and revenue growth tend to be great investments over time. This is especially true when those future earnings streams can be bought at attractive prices. Prevailing negative Chinese sentiment offers a rare opportunity to buy these high-quality businesses at extraordinarily low prices.
In South Africa, the FTSE/JSE Capped All Share Index tracked global markets lower — more so in US dollars after the rand fell sharply against the greenback. While the unit is nearly 10% lower against the dollar this year, weaker terms of trade and rising budget deficits remain headwinds for the currency. Falling resources counters weighed heavily on the bourse due to falling commodities prices, including gold and copper, although oil was higher. The SA bond market was mildly weaker.
The Foord Equity Fund again outperformed its Capi benchmark in the falling market. The fund’s structurally lower weight to cyclical resources shares helped its relative performance, as did the fund’s cash balance and preference for rand-hedge counters. Negative Chinese sentiment weighed on the performance of the Foord global funds despite their cautious positioning. Currency weakness offset these negative returns in the Foord multi-asset funds in South Africa.
Inflation in all markets is now well off its peaks, even if core inflation — which excludes volatile energy and food items — remains sticky. The future path of global interest rates is highly dependent on how much — and how quickly — inflation recedes towards acceptable levels. We see five major risks to the ‘Goldilocks scenario’ of a soft or no-landing in the US economy.
First, US mortgage rates have now risen above 7.5% for the first time in 23 years, leaving the US housing market increasingly unaffordable, frozen and vulnerable. Second, the repercussions of tighter credit conditions due to higher rates have yet to fully permeate the US economic system. Third, higher yields mean a higher interest burden for the US government — which is already spending more than it earns. The US budget deficit will exceed 6% of GDP this year — double that of 2022 — with little prospect of improvement. Fiscal spending is a big part of why the US economy has remained so robust, but the deficit could balloon if the economy slows. Fourth, US wages rising faster than consumer prices will squeeze corporate profit margins. Lastly, the combination of dwindling savings, higher interest rates and the resumption of student loan repayments pose threats to consumer spending.
For these reasons and more, we remain cautious about market exuberance or aggressively buying the market’s dips. We continue to avoid heavy investment in the most expensive sectors of the US and global equity markets. The recent volatility is a powerful reminder of the importance of remaining steadfast. We aim to capitalise on sentiment-driven volatility to help deliver meaningful, inflation-beating returns for our investors through the cycle.
While inflation should continue to fall from a high base, the risk of higher inflation over the long-term horizon remains. For this reason, our portfolios continue to favour investments that can withstand or even benefit from higher inflation. With over 40 years’ experience of managing money, Foord has proven its ability to deliver good investment outcomes over full market cycles. Investors should rest assured that the discipline, consistency and reliability of our investment process will also bear fruit in this market cycle.