MARKETS IN A NUTSHELL — FOR SEPTEMBER 2023
As autumn descended on the Northern Hemisphere, it brought with it a chill on Wall Street. Global equity and bond markets both sold off sharply — September was the worst month for the US S&P500 Index this year. US stocks have now fallen more than 7% since their July peaks. As with the rally earlier this year, the selloff was valuation and not earnings driven — a stark reminder that thematic rallies are vulnerable to rapid reversals.
Despite tough talking, the Bank of England and US Federal Reserve both held interest rates at their recent peaks. However, the US bond market did its own hiking: yields on US government bonds surged across the board and bond prices fell. The US 10-year Treasury yield closed at around 4.6% and is back at levels last seen in 2007 — before the Global Financial Crisis.
The rise in the US 10-year Treasury yield is notable because it is widely regarded as the valuation backbone of all other markets. It is the ultimate (so-called) risk-free asset, from which all other assets are priced. Since asset prices move inversely to yields, a collapse in the price of the world’s foremost risk-free asset suggests that all other asset prices are also at risk.
The combination of resilient growth and higher yields was a boon to the US dollar, which advanced markedly against most currencies in September. Another noteworthy move that threatens the disinflation narrative is the marked uptick in energy prices. Oil prices threatened to reach $100 per barrel, thanks mostly to supply cuts from Opec+ leaders Saudi Arabia and Russia. Industrial and precious metals both traded lower.
In Asia, Chinese authorities continue to roll out piecemeal stimulus measures, with possibly more to come. The intervention stemmed the underperformance of Chinese bourses, which fell less than global developed market peers. The case for a bounce back in China rests in large part on its tech prowess. According to a recent Australian Strategic Policy Institute study, China leads the US in 37 out of 44 tech fields — from AI to robotics. The Foord global funds are well positioned to benefit with their attractively priced investments in quality Chinese technology and consumer discretionary names.
Except for its income funds, all Foord funds were lower, given this environment. Short US market positions in the Foord International Fund helped to pare losses, but deratings in core materials names FMC Corp, Freeport-McMoran and Wheaton Precious Metals — compounded by retracement in the physical gold position and yield-proxy SSE — worked against the fund this month.
In South Africa, the Foord Equity Fund continued to outperform in the falling market — a hallmark of the fund’s investment style. The fund is now showing alpha after fees and expenses for the last three years. The Foord fixed income suite turned one at the end of September. The Foord Income Fund and the Foord Flex Income Fund were cautiously positioned but outperformed their benchmarks for the year. The Foord Bond Fund took no big bets and performed in line with the All Bond Index for the year.
Looking ahead, we could be at a major inflection point in the global interest rate cycle, with big implications for asset valuations. In 1981 — after a multi-year period of rampant inflation — the US 10-year yield reached a peak of 15.8%, with bond prices plumbing all-time lows. This heralded the advent of a 40-year bull market in bonds as the 10-year yield fell to an ultra-low level of 0.5% in 2020. As a result, investors today are heavily invested in bonds and hard wired to buy them whenever yields tick up, as they have done this year.
The problem is that the global risk-free asset no longer seems entirely risk free. US government debt has ballooned, but high borrowing requirements suggest that a glut of supply is still coming to the bond market. With US investors already full up on bonds and countries such as China starting to substitute gold for US Treasuries, we could be in the throes of a prolonged structural shift in the direction of interest rates.
Since the 2008 Global Financial Crisis, ultra-low interest rates and ballooning central bank balance sheets have provided near constant support for global bonds. With that artificial support reversing, bonds are at the mercy of the market — and the market rate of interest for government bonds may be much higher than what investors have come to expect.
If so, investors should radically rethink their assumptions about how asset prices might behave in future. Valuations across asset classes will have to price in a far higher risk-free hurdle. A much higher discount rate for all future cash flows has implications for the entire global investment landscape. Interest rates have been a massive tailwind for stocks and bonds for 40 years but might now become a structural headwind.
Unless central banks U-turn, investors will need to position for a new set of economic and financial norms. Foord’s view that rates would need to rise rapidly and remain higher for longer has worked very well to protect investors against negative returns in interest rate-sensitive asset classes thus far — and we remain cautious about filling our boots just yet.
The global outlook remains fragile, with risks still tilted to the downside. The ultimate impact to the economy and financial system from the rapid changes in monetary policy is difficult to gauge and could continue to expose vulnerabilities — particularly where valuations are stretched. Pressures in global energy markets may resurface, leading to price spikes and resurgent inflation. Monetary policy will need to remain restrictive until there are clear signs that underlying inflationary pressures have been sustainably contained. Policy rates are likely to remain high well into 2024 — this should be factored into investment decision making.
We continue to be cautious on the US share market which looks expensive. Nevertheless, the global investment opportunity is broader than it was some years back: bond yields once again promise real returns, while inflation-protected bonds offer the highest real yields since 2007. With nominal cash rates where they are, cash is no longer trash.
We continue to keep some powder dry across our funds to deploy into markets as opportunities arise. While risks certainly remain in the macroeconomic landscape, the prospective returns to a sensibly allocated multi-asset portfolio remain attractive if your investment horizon is in years rather than in days or months.