Market Update – September 2023

Rate cuts off the cards

Coming into the summer, investors had been anticipating interest rate cuts late this year or early next. That now looks unlikely as core inflation remains high and central banks have indicated that interest rates may have to rise even further – or stay high for longer than anticipated. As a result, developed market government bond yields have been rising and are now at their highest levels in almost 20 years. Global equity markets have been under some pressure, but remain close to recent peaks. While developed economies have displayed an impressive ability to cope with higher rates, the interest rate outlook means we remain somewhat cautious on equities in the near term. The picture is further complicated by China’s weakening economy. The government in Beijing has announced measures to boost confidence, but markets have not responded particularly positively.

China’s property markets continue to weaken

Some of China’s largest property developers have announced huge losses and sought to restructure their debt in recent weeks. This is prompting questions about whether China now faces a “Lehman moment.” The very muted market reaction suggests that it does not – at least for now. Chinese government bonds have outperformed their US counterparts, while commodity prices and Chinese bank share prices are both above last year’s lows. Investors may be taking some comfort from the fact that recent stress is the result of deliberate policy shifts designed to reduce debt levels and property speculation. These developments will depress growth this year and could still be a source of volatility. However, the transition to lower, but more sustainable, growth may ultimately be a healthy development.

Don’t underestimate the AI revolution

In our view, the stock market’s excitement about developments in artificial intelligence is not unfounded. Schroders’ Head of Global and Thematic Equities recently suggested that AI could allow global companies to cut their wage bill by over $2 trillion per year, as it takes on more of the work done by approximately one billion knowledge workers around the world. Some of these savings will flow to the largest technology companies in the form of additional revenue, explaining the strength of their shares this year. So far, the “picks and shovels” companies that provide chips and computing processing power have been the most obvious beneficiaries. However, we believe that we are still in the early stages of the AI revolution and many other firms will do well. Companies in some sectors may well struggle as AI disrupts established business models.

Portfolio positioning

The probability that US inflation will fall without the economy experiencing a significant slowdown has risen in recent months. We have therefore slightly increased our exposure to equities. While we remain underweight the asset class, we may take advantage of further opportunities to add to our position. We are comfortable with our modest overweight position in government bonds. We anticipate gradually increasing the maturity of our government bond holdings to protect portfolios as the global economy slows. 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.