Market update – November 2023

Markets continue to struggle

Conflict in the Middle East has not helped investor sentiment over the past month. However, the decline we have seen in stock markets in recent weeks probably owes more to volatility in bond markets and continued concern about the impact of higher interest rates on growth. In the US, the 10-year Treasury yield briefly breached the key psychological level of 5% for the first time since 2007, before ending October below this level. Major central banks left rates on hold at their latest meetings, suggesting that they are becoming more confident about the path of inflation. However, this positive development is being somewhat overshadowed by growing concern over supply and demand dynamics in government bond markets. Given high levels of government debt around the world, this could remain a source of volatility for some time.

Is this as good as it gets for the US economy?

Early figures suggest that the US economy grew at an annualised rate of 4.9% in the third quarter, the strongest performance since late 2021. The data suggests that a "soft landing" – lower inflation without a recession – is becoming a reality. Given that this outcome has been increasingly anticipated, however, the news did little to help markets. The US economy is likely to continue expanding, but markets are increasingly focused on future growth headwinds. These include the end of a moratorium on student loan repayments (introduced during the pandemic) as well as the continued possibility of a government shutdown. Consumer spending could also slow from current, strong levels. The personal savings rate is now below average, suggesting that households may soon need to cut back on spending and start rebuilding reserves.

What conflict in the Middle East could mean for the world economy

The complicated geopolitics of the Middle East unfortunately mean there is a risk of the conflict expanding. This could lead to disruption in energy markets, with potentially significant consequences for the global economy. As we saw following the invasion of Ukraine, sudden increases in energy prices have a "stagflationary" impact, depressing growth and raising inflation. In the US, core inflation, which excludes the impact on commodity prices, has fallen to just over 4% from around 6.5% a year ago. While energy prices have little direct impact on core inflation, central bankers will be worried about the “second round effect” of wages rising in response to higher prices. Given that employment markets remain tight, this could lead to further rate rises and delay any pivot to rate cuts. This would add to the pressure on consumers from higher commodity prices, undermining a key driver of developed market economies.   

Portfolio positioning

A peak in interest rates and a continued decline in inflation are two of the key signals we were looking for before turning more positive on equities. It looks increasingly likely that the first condition has been met and there has been significant progress on the second. We have therefore taken advantage of the recent de-rating in equity markets to slightly increase our equity exposure across risk mandates. For now, however, we remain underweight the asset class. This reflects our view that economic growth is slowing as the full impact of rate rises to date is felt. We are comfortable with our modest overweight position in government bonds. Bonds now offer attractive levels of income and could start to offer greater diversification benefits if the global economy slows more meaningfully. We continue to see the appeal of alternatives, which could provide valuable diversification benefits if inflation were to rise again. 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.