Market update – June 2023

A better mood in markets

Just two months ago, investors were fretting about US bank failures. At the start of June, they are cheering a debt ceiling deal and the emergence of another trillion dollar company, Nvidia. Along with other large tech companies, the value of Nvidia has soared as investors grow increasingly excited about the prospects for AI. There are other reasons for optimism. Inflationary pressures continue to ease, although remain above expectation in the UK, and earnings remain resilient. However, with interest rates still at far higher levels than companies and households have been used to, fragilities remain. There are also signs that global economic activity, especially in manufacturing, is starting to slow. This may explain why the performance of US stocks excluding technology has been far more muted.

Debt ceiling battle deferred

The US House of Representatives has agreed to a deal that suspends America’s $31.4 trillion limit on borrowing until the start of 2025. Approval by the Senate and President is expected to follow. While this removes a key near-term risk for the US economy, there are challenges ahead. It is possible that the Federal Reserve further raises interest rates over the summer. Investors may also start to pay greater attention to next year’s US election. Much may change before Republicans and Democrats must choose their nominees, but for now Trump and Biden are the favourites. Even if we do not see a rerun of the 2020 contest, the election could trigger an escalation of the long-running tensions between the US and China. This could depress the outlook for profits and growth in both countries.

Will China’s recovery disappoint?

It looks increasingly likely that China’s post-Covid recovery is not going to be as strong as that enjoyed by other major economies. While it was always expected that the rebound would be focused on services, markets were still disappointed by recent survey data suggesting that Chinese manufacturing may have contracted in May. Even in the more buoyant services sector, data has been falling somewhat short of expectations. The relatively subdued recovery may reflect the fact that excess household savings built up during Covid were lower in China than many Western economies. The property sector also continues to be a significant headwind to confidence and activity, leading to some speculation that the government may introduce additional support measures.

Portfolio positioning

Given our view that the US will fall into recession late this year, our underweight exposure to equities remains appropriate. However, we are looking for opportunities to add as and when markets begin to better reflect the economic challenges ahead. Within equities, we are modestly increasing our exposure to Japan, given an increased focus on corporate reform.

We are now overweight government bonds, which should start to offer more defensive characteristics as inflation continues to fall. We have recently been switching some of our fixed income exposure from US Treasuries into UK gilts, based on the view that markets may be overly-optimistic on US rate cuts. High levels of inflation in the UK have made meeting inflation plus return targets more challenging in the shorter term. Despite this, we remain confident in the ability to meet inflation-plus targets over the longer term.