SNAPSHOT2 min read

Market update - May 2023

Equity markets have remained resilient, despite ongoing stress in the US banking sector.

05/05/2023
Elephant and Mule cartoon - Republican and Democrat

Stock markets hold onto gains

Stress in the US banking sector claimed another victim early this month: California’s First Republic Bank was taken over by US authorities before an emergency sale to JPMorgan. The news resulted in further losses for US bank shares, but has not caused significant declines in broader equity markets. Both US and global shares remain around 8% higher year-to-date in USD terms (4% in GBP terms). Investors may be taking comfort from the fact that threats to financial stability means the peak in US interest rates is closer – a view supported by the latest statement from the Federal Reserve. However, investors may be too optimistic about the prospect for interest rate cuts given the persistence of inflationary pressures. They may also be underestimating the economic risks from tighter banking regulation and lower levels of lending. Both factors reinforce our view that the US will face a mild recession over the coming year.

Is inflation becoming embedded?

Core inflation in the US, UK and Eurozone remains at or above 5.5% and is not yet on a clear downwards trajectory. Signs that labour markets are cooling, especially in the US, suggest this should be on the horizon. However, central banks will be wary of prematurely easing monetary policy and allowing inflation to rise from an elevated base, as was the case in the 1970s. The UK perhaps faces the greatest challenge. It is the only major economy where headline inflation remains in double digits. The latest inflation figures also significantly exceeded the Bank of England’s forecasts, undermining its inflation-fighting credibility. The BoE appears to be further away from an end to interest rate rises than the Fed or ECB.

Debt ceiling deadline moves closer

Concerns over the US debt ceiling are another source of potential volatility. The risk was highlighted by Treasury Secretary Janet Yellen, who warned Congress that the US could be forced into default as early as June 1 without a deal to increase borrowing limits. In 2011, brinkmanship over an agreement resulted in significant turbulence in markets – and the downgrade of the US credit rating. Investors may be anticipating a repeat of this drama, with the cost of buying insurance against a default on US government debt now at record levels. We expect that an agreement will be reached – but this will come at an economic cost: a deal is likely to include some combination of tax increases and spending cuts, further weighing on the outlook for growth and corporate profits.

Portfolio positioning

Our underweight exposure to equities remains appropriate, though we are looking for opportunities to add as and when markets begin to better reflect the more challenging economic environment. As things stand, other asset classes look relatively more attractive. We have been gradually increasing our exposure to government bond markets, which should start to offer more defensive characteristics as inflation falls from very high levels. 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. Gold has also been performing well and we maintain some exposure as part of a blend of defensive assets. 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.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

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