MARKETS IN A NUTSHELL - FEBRUARY 2023
In early February, the US Federal Reserve announced its eighth interest rate hike this cycle. The smaller 25bps increase takes the federal funds rate to 4.75%. With headline inflation slowing, investors were quick to cheer an imminent peak of the interest rate cycle. There was early speculation that the Fed might after all pull off a soft economic landing — or even a fairy tale ‘no landing’.
But sentiment later soured on a sticky US core consumer price inflation reading — the Fed’s favoured measure of inflation — and higher inflation prints in key European markets. The market is now pricing in a terminal federal funds rate of close to 5.5%. Global share bourses trended lower, with the first six weeks of the year now seeming like just another bear market rally.
Meanwhile, the frenzied China reopening trade waned, with Chinese markets falling nearly 10% in US dollars in February. Investors are still cautious on the country’s property sector and whether China can achieve its aggressive growth targets this year. While it seems to us that the western markets are still in the late stages of a bear market, Asian economies are in the early stages of a bull market.
On that note, the US bond market is still portending signs that trouble is brewing: the yield on the two-year Treasury bill reached its highest level since 2007 and the US yield curve is now severely inverted, with the rate on two-year bonds almost 1% higher than on 10-year bonds. This suggests that the bond market believes the rapid rise in interest rates will cause significant economic disruption in the years ahead.
With US interest rate expectations rising quite markedly, the US dollar firmed against most currencies. The rand came under even more strain than most other emerging market currencies due to problems of our own making. More energy was expended deflecting blame for Eskom’s failures than in resolving the energy crisis itself. And while the Budget Speech was generally well received, many investors — including us —remain wary of how likely (or able) National Treasury can adhere to fiscal prudence.
Within the Foord global funds, the Foord International Fund’s short S&P 500 hedges that were allowed to lapse in December were reintroduced at meaningful levels in late January as markets rallied. The hedges contributed most to fund performance in February. The Foord International and Foord Global Equity Funds were weighed down in the month by the retracement of Chinese stocks and materials names.
In South Africa, the Foord unit trust funds benefited from generally low resource exposure as resources stocks fell heavily as commodity prices retraced on broad-based dollar strength and rising global recession worries. Preferred non-resource rand hedge stocks AB Inbev, Richemont and British American Tobacco outperformed, as did select SA Inc. and banking stocks.
The Foord fixed income funds continue to outperform their respective benchmarks over their short history since inception in October 2022. Convertible bonds proved to be a headwind for the Flex Income Fund this month, but remain an important strategy given their attractive return profile and ability to hedge against inflation. The income funds are structured conservatively, with low duration and credit risk, but still deliver yields exceeding 9%. The Foord Bond Fund continues to build its inflation-linked bond exposure while holding a short duration versus the benchmark. The recent Budget highlighted SA’s rising fiscal risks and justifies the fund’s underweight at the long end of the curve.
Looking ahead, with commodity and energy prices falling and pandemic factors fading, wage inflation now poses the single biggest threat to rising price pressures around the world. In the US, Walmart and Home Depot have announced minimum wage increases, effectively setting a new floor for wages in the US. Across the Atlantic, public-sector unions are striking over pay in the UK and Germany. In countries such as Hungary and Poland, wage growth is already in double digits. How successful the world’s workers will be in pressing home their demands for higher pay will be key to the future direction of inflation and interest rates.
Another indicator we’re watching closely is the US housing market: 30-year fixed mortgage rates recently rose above 7%, meaning they have more than doubled in the past year. This has not yet crashed the housing market but is freezing it up — the 90% of bonded US homeowners with fixed-rate mortgages are holding onto their sub-3% rates for dear life. There are no easy options for how this situation resolves itself.
Investors’ fates thus remain closely tied to the future path of inflation and central bank responses. Given our expectations for global inflation to run higher than market participants generally believe, we remain particularly cautious on longer-dated bonds and US growth stocks that still haven’t fully adjusted to higher discount rates.
Instead, we prefer companies that should cope well in inflationary or recessionary conditions. But we’re also keeping some powder dry for the opportunities that the whipsaw of market prices throws up. For the disciplined investor, it’s only a matter of time before today’s volatility provides the opportunity for tomorrow’s best investments.