Market Update August 2023

Volatility returned to markets in August, as investors focused on the darkening macroeconomic picture in China and higher sovereign bond yields. Global stock markets were weak, with the MSCI All Country World Index falling 2.8%. Emerging markets, which are particularly vulnerable to bad news from China, declined 6.1% over the month. There were echoes of 2022, as bond markets offered little protection to investors. Sovereign bond yields rose, with the 10-year US Treasury yield finishing the month at 4.1%.

Throughout the month, financial markets remained fixated on inflation and rate expectations. Current expectations are that rates are at or near peak levels, but there is little optimism that they will return to the very low rates seen prior to the Covid-19 pandemic. Bond market pricing is currently reflecting the view that US short-term interest rates will average 4.0% over the next ten years, compared with an average of 1.2% over the last ten years.

UK

The FTSE All-share lagged its developed market peers during August, as investors remained pessimistic about the outlook for the UK economy.

The Bank of England’s battle against inflation continued to dominate financial market headlines. The BoE increased interest rates by a further 25bps at the start of the month, which now brings rates up to 5.25%. Bank officials indicated that rates will remain restrictive for some time to come.

On a more positive note, there is evidence that inflation in the UK is finally slowing. UK headline CPI came in at 6.6% year-on-year, versus 7.9% in the prior month. That being said, growth in regular pay hit the highest level since records began in 2001. As such, investors still expect a further rate increase before the end of this year. At the same time, the 10-year Gilt yield reached 4.4%.

UK house prices fell at the fastest annual pace since 2009 in August as the impact of higher interest rates hit the property market. The average house price declined 5.3% last month compared with the same period last year, down from a 3.8% contraction in July and the sharpest fall since July 2009.

In politics, the Labour Party’s opinion poll lead over the Conservatives averaged 19% over the summer, in line with readings in the previous 18 months. On the basis of August’s polls, the website Electoral Calculus puts the probability of a Labour achieving a parliamentary majority at the next general election at 93%.

US

August began in dramatic fashion, as the credit agency Fitch downgraded the US government’s credit rating from AAA to AA-. Fitch said concerns about the quality of fiscal management and high levels of government borrowing were behind the decision. Despite this, government bond yields remained relatively stable in the following days.

As the month progressed, yields rose on the back of robust economic data. Higher yields weighed on the equity market, with the S&P 500 declining by 1.6%. Big Tech stocks were particularly vulnerable, with Apple down as much as 11% at one point in August, but recovered to finish the month down 3%. Despite this, there was plenty for AI bulls to get excited about as Nvidia released their quarterly earnings which came in well ahead of estimates.

Inflation remained the main economic story during August, with the Consumer Price Index cooling slightly on both a headline and core basis. Labour market data came in marginally below consensus expectations, yet both wage and employment data remained resilient. At the same time, retail sales for July performed much better than predicted by economists.

The Federal Reserve’s minutes from their July meeting were released mid month which showed that most members are worried that the fight against inflation is far from over and could require further tightening action. In response, the US 10-year government bond yield rose to more than 4.30%. The last time that the 10-year yield was this far above the S&P 500 dividend yield was September 2007, the month that stock markets peaked. Higher yields pushed the US dollar 1.7% higher on a trade-weighted basis.

Despite the plethora of charges facing Donald Trump, he remains the front-runner for the Republican Party nomination. An average of major national polls released since early July put Joe Biden on 46% of the vote and Donald Trump on 44%.

Europe

European equities fell 2.2% as bank stocks sold-off after the Italian government announced an increased tax on the sector. On a more positive note, Swiss bank UBS announced a $29bn pre-tax profit which can be attributed to a accounting gain from its takeover of rival Credit Suisse. Since agreeing to rescue Credit Suisse in March, UBS shares have risen 30%. The Euro Stoxx Banks Index, which tracks fellow European lenders, is up 16% over the same period.

European economic data was mixed during August. Quarter-on-quarter GDP growth picked up modestly, but labour data remained tight, with unemployment at the lowest level on record. PMI survey data dropped to 47, which, excluding the Covid-19 pandemic period, is the most pessimistic outlook since 2012.

Core Eurozone inflation fell modestly, but the rate of inflation remains materially above the European Central Bank’s target. As a result, investors continue to expect further rate increases this year.

Asia

Concerns about China’s economic performance have grown over the summer. A much-anticipated-post-Covid boom has failed to materialise and, in contrast to Europe and the US, price pressures have receded rapidly. CPI turned negative in July at -0.3% year-on-year, while producer price index deflation continued for the tenth month in a row.

Last month, China ceased to report its soaring youth unemployment rate, a move that critics see as an attempt to obscure the slowdown in growth. In response to the economic slowdown, the Chinese government have sought to bolster the economy by cutting interest and mortgage rates and by stepping up support for the renminbi, which has fallen by more than 5.0% against the dollar this year.

While the Chinese recovery has disappointed, the Japanese economy and stock market have continued to outperform. The economy expanded by 6.0% quarter-on-quarter in the second quarter of 2023 on the back of a strong contribution from net trade. Activity indicators such as the Tankan index indicate a continuation of this strong momentum in the months ahead.

Japan seems to be finally turning the page on its deflationary period, with core CPI up 10 bps to 4.3% year-on-year in July and spring wage negotiations leading to the biggest wage increases in 30 years. Japanese equities proved relatively resilient in August as the Topix posted a modest gain of 0.41%.

Commodities

Global oil prices took a breather in August after strong performance in July. Production cuts were supportive of oil prices, however this was offset by concerns around Chinese growth. At the end of the month West Texas Intermediate traded above $81 a barrel, after advancing 3.5% in the longest run of daily gains since March. Stockpiles in the US fell by 10.6m barrels in the final week of August, hitting the lowest level since December 2022.

Elsewhere in commodities, European natural gas prices soared 23% due to the risk of strike action at major LNG plants in Australia.

Outlook

The global economy continues, by and large, to do slightly better than expected, with inflation beginning to fall and economic output proving resilient despite higher rates. As such, the odds of the US and Europe achieving some form of soft landing for their economies have continued to rise, but such an outcome is far from certain. We will continue to monitor events in China closely and seek out opportunities to deploy capital where we feel negative market sentiment is overdone.