FEBRUARY 2023 Market Report
Investment Review
Summary
During the one-month period to 31st January 2023, major equity markets, as measured by the aggregate FTSE All – World Index, rose moderately, by nearly 6%, in dollar terms, one of the best January performances in recent years. Chinese equities and related emerging markets, NASDAQ and Continental European indices led the advance. The UK and Japanese indices underperformed but still rose by 4% in local currencies. The VIX index fell, finishing the period at a level of 19.28.
Government Fixed Interest stocks also rose over the month. The UK 10-year gilt ended the month on a yield of 3.33% with corresponding yields of 3.64%, 2.29% and 0.49% in USA, Germany, and Japan respectively. Speculative and lower quality bonds, also, rose in price terms. Currency moves featured a weaker US dollar. Commodities were mixed on the month, the Chinese re-opening story prompting large moves in the industrial metals.
Monthly Review of Markets
Equities
Global Equities rose strongly in January, gaining over 5.98% in dollar terms, in aggregate, led by NASDAQ and China, and related. Amongst the major indices Japan and the UK lagged, though still each gaining over 4%. Reflecting the greater “risk on “mood the VIX index fell below 20 to a level of 19.28.
UK Sectors
Sector moves were mixed and quite large over the month, the difference between the best and worst FTA sub sectors near 20% over just one month. Travel and Leisure and retail stocks gained over 15% while non-life insurance, pharma and tobacco fell in absolute terms. Telecommunication and bank stocks were reasonably firm, partly on takeover rumours. The FTSE100 underperformed the All-Share Index for the first time in many months. By IA sectors, UK active unit trusts are matching benchmark indices, trackers etc, over the short one-month period, with small company funds about 1% behind. “Balanced” funds, by IA definitions, rose by about 3% to 3.5%, depending on the equity content.
Fixed Interest
Major global government bonds rose 2.2% in price terms over January, the UK 10-year yield for instance finishing the month at a yield of 3.33%. Other ten-year government bond yields showed closing month yields 3.52%, 2.29% and 0.49% for US, German and Japanese debt respectively. See the Bloomberg graph below to compare the “January “bond performances over the last 30 years UK corporate bonds also rose, outperforming gilts, and more speculative debt also finished the month on lower yields.
Check my recommendations in preference shares, selected corporate bonds, fixed interest ETF’s , zero-coupons, speculative high yield etc. A list of my top ideas from over 10 different asset classes is also available to subscribers.
Foreign Exchange
A stronger pound and weaker US Dollar were the main moves, where cable (£/$), for instance, rose by 2.3%The Chinese Renminbi strengthened by 2.8% against the greenback. The Japanese Yen initially showed appreciation as a follow through from December’s yield control mechanism tweak, but more nuanced Bank of Tokyo statements during the month, reversed some of the gain. Interestingly,adjusted for FX moves,UK,Japan and USA all rose by between 3% and 4% on the month.
Commodities
Industrial metals copper, aluminium and iron ore showed the largest monthly move, while natural gas and several soft commodities declined in actual terms. Gold rose modestly but other PGM’s showed little monthly change.
News
Over the recent month, there have been few major changes to formal aggregate economic growth projections, with most commentators pointing to the “management” of the US slowdown, nature and timing of the Chinese re-opening and the Russia/Ukraine conflict as being key determinants of forward-looking estimates. At regional level however, more optimism is apparent in Continental Europe.
At the same time, key data inflation indicators (headline rates, factory gate and commodity prices, shipping rates,) suggest that headline price growth is set to slow in coming months, although labour compensation developments must be watched carefully.
US
Recently announced inflation indicators showed December headline CPI of 6.5%, lower than estimates. The November PCE,the Fed’s preferred inflation metric rose at an annualised rate of 5.5% still over double the Fed target. Fourth quarter preliminary GDP growth of 2.9% (3.2% in third quarter), annualised, while higher than estimates, concealed a slower consumers’ expenditure. This relative weakness has also been backed up by consumer sentiment indicators, retail sales, housing activity, construction figures and the Empire States Survey. The Fed’s own forecasts expect GDP growth of 0.5% for 2023, and core PCE growth of 4.8% and 3.5% respectively for 2022 and 2023.The employment situation remains relatively resilient overall, despite the headline grabbing news of cutbacks in the technology sector.
At its final 2023 meeting on 14th December, the Federal Reserve raised its benchmark policy rate by 50 basis points and signalled its intention to keep squeezing the economy next year as central banks on both sides of the Atlantic enter a new phase in the battle against inflation. The new target range is 4.25% to 4.5%. Latest Fed projections below. At this time of writing we are waiting for the latest Fed move, probably 25bp increase, and the accompanying statement.
There is growing concern (again) that the US government may hit its ceiling for debt issuance this summer and spark speculation about a looming default. This “ritual” has of course been played out many times in the past, but coming this year, when the Central Bank is trying to reduce its balance sheet, there could be reasons to expect bouts of bond market volatility over coming months.
EUROPE
ASIA excl JAPAN
The GDP figures, shown below (source: CLSA, CEIC) show 2022 and 2023 growth projections for the Asia excl Japan region. Growth in 2023 is likely to slow slightly amid weakening domestic and external demand after 2022, the fastest since 2012, but overall, the situation still compares favourably by international comparison The reasons include a “better” Covid experience, selective commodity exposure, tourism, continued FDI Investment (especially China related) and better initial fiscal situations (compared with late 90’s for example) and limited direct connections with the Russia/Ukraine situation. The forecasts do not assume a total easing of Chinese covid rules.ASEAN,which includes Indonesia,Malaysia,Philippines,Singapre,Thailand and Vietnam expect aggregate economic growth of 4% for 2023.
Headline inflation of around 5% currently (core 3%) also compares favourably and is expected to drop to nearer 4% by end 2023 led by commodity disinflation.
CHINA
The 5.5% official GDP growth target for 2022 was predictably missed, the actual figure emerging at around 3%. Official historic data showed weakening trends in consumer spending, fixed asset investment and construction activity while more recent (December)t “live” tracking data e.g., mobility, cement production and electricity use also showed subdued economic activity. In addition, very weak trade data was released mid-December. The major historic negative issues of a very restrictive anti-Covid policy and major disruption within the property market have now been supplemented by increasing US restrictions on the production/export of certain key electronic products.
At the time of writing however, a property “rescue” package has been implemented, while on the Covid front, various relaxation measures are taking place to alleviate some of the issues above. The removal of the quarantine requirement for inbound travellers from January 8th signalled the end of the zero-Covid system that transformed China’s relationship with the outside world. Independent medical statistics and anecdotal evidence (crematorium activity,chrysanthemum sales!) show a rapid increase in Covid cases and deaths, probably exaggerated by the Chinese New Year, but a positive economic momentum is starting to build. First manifestations are starting to appear in Chinese travel and leisure statistics while a manufacturing revival will take much longer, especially in the face of slowing US demand.
At a recent cabinet meeting, premier Li Keqiang vowed to make consumption(currently only about 40% of GDP) the “driving force” of the economy, unleashing some of the savings amassed during the Covid years.
JAPAN
The Japanese economy contracted 1.2% on an annualized basis during the third quarter of 2022, missing forecasts of 1.1% growth, and considerably weaker than the 4.6% expansion recorded during the second quarter. This was the first down quarter of the year reflecting weak domestic consumption, a slowdown in business investment and an acceleration in imports. Estimates for the full year seem to fall mainly within the 1.5%-2.0% band. Inflation, while still well below international peers, rose by 4.0% in December, the highest in 41 years, driven by currency weakness. Headline CPI is expected to remain around this level in coming months through a combination of import prices and elevated consumer expectations. Wage developments should be watched carefully over coming months and although the Fast Retailing (UNIQLO) 40% increased wage offer was a one-off, there will be focus on the upcoming spring labour negotiations which could have large implications for inflation, interest rates and consumer expenditure. The Bank of Japan changed its yield control policy towards the end of December surprising many investors and causing immediate drops in bond prices and gain in the Japanese Yen. Although denied by the BOJ,there is growing speculation that Japan may ease back on its ultra-loose monetary policy in spring 2023 when the BoJ leadership changes.
.
UNITED KINGDOM
Within the UK, live activity data (e.g January Gfk data) continues to show a weaker overall trend, especially within the services sector. According to this survey, released mid-January, covering the mid-month period, consumer confidence remains very low (near a 50 year low), amid the cost-of-living crisis. This followed the publication of figures showing a drop in total 2022 retails sales of over 6%. Unemployment, however, is still at a relatively low level.
According to ONS statistics, GDP fell by 0.3% between the second and third quarters, slightly more than expected, and leaving the economy 0.8% below the “pre pandemic” level. The “increase” of 0.1% in the monthly November figure may be partly due to the “World Cup” effect. The saving ratio was 1.8% during the quarter, and banks report increases in credit card borrowing.
Inflation rose at 10.5% in December a slight improvement on the November figure, with core inflation at 6.5%. Latest earning growth around 6.5% is still a concern for BoE policy makers.
The PSBR is still hovering near all-time records, with the 2022/2023 figure expected to be about £50 billion higher than the 2021/2022 figure, already a record high.
Despite some relief with the recent energy price package, until April at least, (but not other utilities-see below), shop price inflation, greater Council Tax “freedom”, upward interest/mortgage rate pressure, falling house prices, accelerating rents, insolvencies/evictions, legacy Brexit issues and strike activity, will continue to be headwinds and the outlook for economic growth over coming quarters is highly uncertain. The Bank of England expects recessionary conditions to last for a few quarters though a recent Andrew Bailey statement hinted at a less severe slowdown than forecast around the time of the ill-fated mini Budget.
Experts at consultancy EY-Parthenon, insolvency specialist Begbies Traynor and, more recently, data from Insolvency Services to December 2022 all point to a huge increase in the number of distressed companies, predominantly in the small and medium size company area. While consumer facing sectors continued to be most affected EY said that “stress” was deepening across all sectors.
Monetary policy has tightened from a 0.1% interest rate in December last year to the current level of 3.5% warning that further hikes are likely. Markets are expecting rates to be above 4.0% by mid-2023.One particularly worrying development is the number of fixed rate mortgages that must be renegotiated over next quarters at much higher rates.
Looking Forward
Given the scope for geo-political, economic uncertainty from known factors summarized above plus the “black swan” allowance for unknown developments, plus the valuation risks, more prominent in certain asset classes than others, the first message for 2023, should be diversification, and the second should clearly be scaling your positions according to your risk profile.
scaling your positions according to your risk profile.
KEN’S TEN-2023
• Keep an overweight position in renewable/infrastructure.
• Favour value over growth generally-trade has further to run.
• Stay neutral/overweight in UK equities relative to your benchmark (page15).
• Overweight Far East,including China,Japan and other Asia (pages 16-19).
• Start switching large cap to small cap-valuation/performance.
13
• Start diversifying away from strong dollar.
• Overweight uranium relative to your commodity benchmark (page 21).
• Amongst UK sectors overweight telecom, health equipment, defence, tobacco and energy (pages 13-14),”not too ESG friendly,I am afraid”.
• Amongst UK sectors underweight luxury, motor related, most capital goods, consumer brands and food retail (pages 13-14).
• Within UK Fixed Interest prefer corporate bonds, preference shares, and zeroes to conventional gilts (page 21)-start rebuilding some fixed interest exposure, especially for cautious and balanced risk profiles.
For equities generally, the two medium term key questions will be when rising interest rates eventually cause equity derating/fund flow switches, government, corporate and household problems, and how the rate of corporate earnings growth develops after the initial snapback. Going forward, withdrawal of certain pandemic supports, uncertain consumer and corporate behaviour and cost pressures are likely to lead to great variations by sector and individual company. Investors will need to pay greater than usual attention to the end 2022 figures and accompanying forward looking statements.
Market Arithmetic
UK Equities continue to remain a relative overweight in my view, based on several conventional investment metrics (see above), longer term underperformance since the Brexit vote, style preference (value overgrowth) and international resource exposure although be aware of the numerous domestic headwinds I have highlighted above.
Value should be favoured over growth, and the FTSE 100 favoured over the FT All-Share. Apart from the style drift, remember that the non-sterling element of leading FTSE 100 companies and sectors is relatively high
Overweight
By sector, Oil and Mining equities continue to benefit from above average yields, strong balance sheets, dollar exposure and secular demand e.g copper,lithium, cobalt for electronics, construction, electric vehicles etc. Current moves regarding Chinese re-opening the economy would be another positive for this sector.
Remain overweight in pharmaceuticals and health equipment, expect more corporate activity
Telecom-moving to overweight this area after many years of disappointment. Valuations are attractive, many tariffs have an element of index linking, windfall tax risk is low and sector consolidation is increasing.
Defence-a relatively small stock market sector in UK terms but increased global defence spending, negative PMI correlation, high barriers to entry and corporate activity will continue to lift this specialist area.
Tobacco-ESG factors aside, there is undoubted value in this sector (both major UK stocks yield around 7%). Negative correlation with PMI’s and emerging market volume growth still strong.
Banks may enjoy some relative strength from rising interest rates but continue to monitor the recession/loan growth and default risks. These mixed trends were very evident in the recent third quarter figures. Preference Shares as well as ordinary shares have attractions in this area.
Underweight
Utilities- underweight in non-renewable utility stocks which may suffer from consumer and government pressures, and no longer trade on yield premia, especially against the backdrop of higher gilt yields. Infrastructure may fare better than distribution.
Housebuilders and real estate-expect depressed activity and remember that the rising interest rates have not yet been fully factored into bricks and mortar property yields. Industry data and anecdotal news from both housebuilders and REIT’s suggest further weakness to come.
Retailers are in general suffering from a combination of falling sales and rising costs and clear trends in consumers “trading down” are apparent. Anecdotal evidence shows a clear switch in consumer spending away from discretionary items such as electronics, furniture and certain clothing items. Certain on-line operations e.g Asos additionally are suffering from an element of post-Covid comparison. Food retailers are additionally facing stiff competition from discount “disruptors”. The British Retail Consortium expects another tough year for the sector looking for sales growth of just 2.3% to 3.5% i.e., volume declines.Share price performance over January has been very mixed.
Luxury Goods-Currently highly rated in stock market terms but could be vulnerable, in recessionary conditions and seem to have a strong correlation with property prices, which are expected to decline. However, renewed Chinese interest may help sector.
Domestic Breweries/pubs etc are having a hard time with stalling consumer’s expenditure, supermarket competition and rapidly rising costs.
In general, extra due diligence at stock level more generally will be required as I expect a growing number of profit warnings and downbeat forward looking statements.
However, takeover activity is also clearly increasing with, for example, private equity snapping up UK-listed companies at the fastest pace for more than twenty years. Foreign takeover, stake building is also increasing, current weak sterling being a factor, with Vodafone under scrutiny by a French (who already have BT interest!) investor. Biffa (waste management),MicroFocus(technology),Aveva(software) and RPS(professional services) have all succumbed to foreign takeovers in recent months, much by “strong dollar” American or Canadian organizations.
JAPANESE EQUITIES also remain an overweight in my view, although my recent comment re hedging may “nuanced “now following the extreme currency weakness and surprise intervention/policy change. The prospective price/book ratio of 1.2 is attracting interest of corporate and private equity buyers, while the prospective yield of 2.7% is above the world average and compares very favourably with USA (1.7%). Corporate governance is rapidly improving with diverse boards, reduction of cross holding, higher dividends etc. There are clear signs that inward investment attracted by the pro-growth, pro-deregulation agenda and relatively low costs (average Japanese annual wage $30000 compared with $75000 USA) is increasing. The political agenda is likely to include a more active defence policy,and a shift in income distribution more in favour of middle-class households. Private equity stake building interest in Toshiba and growing activity in the property sector (discount on a discount in a cheap currency) demonstrate the search for value in Japan. Investors may wish to remove currency hedges.
On a valuation basis (see table above) the forward market PE multiple of 11.9 is at a considerable discount to the world, and especially US average (16.7) and certain Japanese investment trusts yield more than UK peers.
EMERGING MARKETS– Very difficult to adopt a “blanket” approach to the region even in “normal times”, but especially difficult now, with so many different COVID, commodity, sectoral mix, debt, geo-political and increasingly natural disaster variables. See chart below The IMF recently warned that several emerging nations could disproportionately suffer from a combination of COVID and adverse reaction to “tapering” by developed counties e.g., FX/Interest rate pressures. Six countries have already defaulted during the pandemic, and the IMF is currently in various stages of bail-out discussions with Pakistan,Argentina,Zambia,Sri Lanka,Ghana,Tunisia and Egypt.
Within the emerging/frontier universe I continue to have a relatively positive view on Asia. The economic fundamentals were discussed on page 16 above, and the forward-looking multiples and dividend growth metrics appear relatively attractive in a global context. Any move by China to open more fully after their severe Covid lockdown, would of course additionally help. Exposure to the entire area can be achieved through several ETF’s and also investment trusts currently on discounts.
If a country-by-country approach is adopted, I have a longer-term positive view on Vietnam
where, the nation is supported by positive demographics, with a population of near 100 million, an emerging middle class, and a recipient of strong foreign direct investment. Qualconn,an Apple supplier, Intel(semi-conductors),Lego and Samsung(mobile phone plant) have all recently invested in new capacity in the country. Other big names moving chunks of production from China to Vietnam include Dell and HP (laptops), Google(phones)and Microsoft (Games Consoles) The economy is expected to grow at around 6.5% this year (7.7% Q2 2022) and approximately 6% in 2023 while current inflation is running at about 3.5%. One more rate hike of 50bp towards the end of the first quarter should mark the end of the tightening cycle. On a relatively low prospective PE based on forecast earnings growth over 20%, Vietnamese equities appear good value.
India, although quite highly rated and a major oil importer, warrants some inclusion in a diversified portfolio although recent corporate scandals(Adani?) require watching. Indonesia, the last of my current Asian ideas benefits from a commodity boom, strong domestic market, low debt, relatively stable currency, forecast 5% GDP growth and 5% inflation.
Caution is required in many South American markets with poor COVID-19 situations, deteriorating fiscal balances, weak investment, low productivity (see below) and governments in a state of transitioning e.g Brazil. However, some stock market valuations currently appear interesting in the region, which, so far, has been relatively unaffected by events in Ukraine. Commodity exposure, deglobalization beneficiary, valuation and recovery from a very low-level account for some year-to-date stock market relative out- performance. Many of these countries also raised interest rates at an earlier stage, allowing relative currency strength, compared with say the Euro,Yen or Sterling.
COMMODITIES– Gold spiked to over $2000 in March 2023, a recent high, when Russia invaded Ukraine, and although currently staging a modest rebound is still only $1924. Central Banks have been aggressively topping up their holdings during 2022.The longer-term prospects for more cyclical plays, however, continue to look brighter. Increased renewable initiatives, greater infrastructure spending as well as general growth, especially from Asia, are likely to keep selected commodities in demand at the same time as certain supply constraints (weather, labour and equipment shortages, Covid, transport) are biting. Current relaxation of the Chinese Covid policy, has certainly provided a boost to copper, aluminium and iron ore.
• Wheat and other grain prices have fallen from the levels reached following the Russian invasion of Ukraine, but the current grain shipment complications, planting/harvesting schedules within the region and extreme global meteorological conditions are expected to lead to further price volatility. If the conflict is prolonged it will affect millions of people living in such places as Egypt, Libya, Lebanon Tunisia, Morocco, Pakistan and Indonesia that could have political consequences. There has been renewed interest in agricultural funds as well as the soft commodities themselves.
• URANIUM-I remain positive on the outlook for nuclear energy (stable base load,carbon-friendly,government U-turns,high energy output) while being aware of some of the well know issues(time, cost and waste disposal).Uranium is expected to experience a material market deficit over the next few years (estimates range between 10% and 30% of global demand).Nearly half of current world mined supply comes from Kazakhstan/Russia. The current price of 50 cents per pound could easily rise to 60c to 70c,as a result of geopolitical tension and a sharply rising cost curve. Apart from capital good companies exposed to the reactor construction/maintenance, I strongly recommend some exposure to my favoured investment trust.
UK FIXED INTEREST-selective exposure now recommended, especially for cautious/balanced risk mandates.
The graph below plots the progress of the UK 10 year gilt yield, which is at 3.33% at the time of writing. The two key things to note are firstly, the extremely low yields prevailing, just a year ago, partly reflecting a prolonged QE programme, and secondly the “panic” level reached at the end of September as domestic and international investors briefly took flight at the prospect of the short-lived Truss/Kwarteng mini budget proposals. Translating this into price terms, the I share all gilt index fell over 35% from the beginning of the year to late September before bouncing about 13% to current levels. This is huge volatility for an asset class often regarded as haven quality!
Having been negative on gilts for several years, I am now recommending gradually re-introducing selected fixed interest stocks to balanced portfolios, especially for cautious and balanced risk mandates.
Gilts themselves will have to contend with huge supply issues over coming quarters. While not falling as much as gilts and having completely different supply/demand dynamics, selected preference shares also fell to reach yield levels of approximately 7%, while good quality corporate bonds now offer yields around 6%. For the more adventurous, annual income yields around 10% and the prospect of capital gains are also also offered on more speculative grades.
GLOBAL CLIMATE CHANGE remains a longer-term theme, and will be built into the many infrastructure initiatives, being pursued by Europe, USA, and Asia. The Russia/Ukraine conflict is accelerating the debate, and hopefully the action. There are several infrastructure/renewable investment vehicles which still appear attractive, in my view, combining well above average yields and low market correlation with low premium to asset value. The recent volatility in natural gas prices has highlighted both risks and opportunities in the production and storage of energy from alternative sources. My favoured vehicles {solar,wind,storage and infrastructure) in the UK investment trust space have delivered capital returns of approx. 10% and additional dividend income of between 5% to7% over 2022 and are expected to continue to deliver healthy total returns.
COMMERCIAL PROPERTY-
The MSCI/IPD Property Index showed a further fall in the total return across all properties in December, the decline of 3.3%), taking the full year 2022 decline to 10.1% (capital –14.2%, Income +4.7%). The monthly decline which started in July has affected all sub-sectors with industrial properties faring the worst over the full year. Rental growth however has been positive at with a 3.2% annualized gain in December taking the full year growth to 4.2% Several analysts are down grading their estimates for the sector following the rapid move in UK longer and shorter-term interest rates. Property asset valuations take time to materialise where there is a lag between balance sheet date and results publication in the listed area. Live traded property corporate bonds, however, have already moved sharply lower.
Quoted property giants British Land and Land Securities both reported deteriorating conditions writing their third quarter statements, expecting further valuation declines following rising yields.
Full asset allocation and stock selection ideas if needed for ISA/dealing accounts, pensions. Ideas for a ten stock FTSE portfolio. Stock/pooled fund lists for income, cautious or growth portfolios are available. Hedging ideas, and a list of shorter-term low risk/ high risk ideas can also be purchased.
I also undertake bespoke portfolio construction/restructuring and analysis of legacy portfolios.
Independence from any product provider and transparent charging structure
Feel free to contact regarding any investment project.
Good luck with performance!
Ken Baksh Bsc,Fellow (UK Society of Investment Professionals)
kenbaksh@btopenworld.com
1st February ,2023
Important Note: This article is not an investment recommendation and should not be relied upon when making investment decisions – investors should conduct their own comprehensive research. Please read the disclaimer.
Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ regulatory filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.The author may hold positions in any of the securities mentioned
The author explicitly disclaims any liability that may arise from the use of this material.