Market update – October 2023

A plateau rather than a peak in interest rates

For most of this year, equity markets have been rising while government bonds have been drifting lower. This traditional relationship came under pressure in September, as both equities and bonds fell together in an unwelcome reminder of 2022. The shift appears to have been driven by a rising awareness that interest rates will need to remain high for some time to bring inflation back to target – more “Table Mountain than the Matterhorn,” as the Bank of England’s Chief Economist memorably put it. Higher commodity prices, especially oil, have also been fueling concern about inflation and interest rates. On a total return basis to the end of September, global equities are down 6.5% from their peak. The weakness in sterling has limited the drawdown in GBP terms to just -2.6%.

US dodges another crisis, but government debt remains a worry

Investors have also been concerned by congressional wrangling over the US budget. An eleventh-hour agreement has averted the risk of a government shutdown, but only for 45 days, raising the prospect of another battle later in the year. While a shutdown would have been a headwind to growth, it is far from unprecedented; it has occurred 10 times in the past 40 or so years. However, the episode comes just months after similar brinksmanship over the US debt-ceiling and is a reminder of the risk and uncertainty that can come with high levels of debt and large deficits. It was almost exactly a year ago that the UK government found itself in a stand-off with the bond markets over its fiscal plans. More recently, European bond markets have been under pressure amid concern about a larger-than-expected Italian budget deficit.

A multi-speed world

The latest US data generally points to an economy that is slowing but still expanding. Figures from China and Europe paint a different picture. Schroders’ economists have cut their expectations for Chinese growth this year to 4.8%, almost two percentage points lower than at the start of the year. Over the coming months, we expect to see further support measures from Beijing, but not the kind of “shock-and-awe” stimulus that we have seen in the past. The weakness has been spilling over into Europe, where activity has also been hampered by high energy prices. As a relatively self-sufficient economy, the US is insulated from some of these challenges. However, very sluggish growth in significant parts of the world economy puts more pressure on the US consumer as the engine of global growth.

Portfolio positioning

US inflation continues to fall while its economy remains relatively resilient. We are therefore taking advantage of the recent de-rating in equity markets to slightly increase our exposure across risk mandates. Importantly, we remain underweight equity compared to our long-term strategic allocation. This reflects our view that economic growth is slowing and that it is too soon to declare victory against “sticky” core inflation. 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 believe that alternatives have an important role to play in portfolios. Our view that many UK alternative investment companies are undervalued has been supported by recent corporate activity in the sector.