The first half of 2023 has been positive for financial markets. The MSCI World Index, for example, has registered gains of just under 14% in US dollar terms, and around 8% in sterling terms. And following last year’s crash in financial assets, investment returns thus far this year have brought with them a measure of relief.
This time last year, stocks were down some 20%, while bonds had lost 10% of their value. The first six months of this year have gone some way towards helping investors to recover their losses. The driving force behind the recovery has been a more favourable outlook for US central bank policy and inflation, as well as (to many people's surprise) the resilience of the US economy.
Unfortunately, this does not hold equally true in regions such as the UK and Europe. Both the Bank of England and the European Central Bank continue to raise interest rates in a bid to tame stubbornly high inflation. In the UK, families are still struggling with soaring household and mortgage costs.
The Governor of the Bank of England has denied trying to engineer an economic slump by raising interest rates to levels not seen in 15 years. That said, our economy is hovering on the brink of recession. Even Rishi Sunak has warned of a possible downturn in 2024.
It should, however, be pointed out that this stock-market rally actually started in mid-October 2022, which was when bear-market lows were recorded. Admittedly, the Wall Street rally has been more sentiment-driven, with the increasingly widespread belief that the US Federal Reserve Bank is reaching the end of its current monetary policy tightening programme: indeed US inflation seems to be on a downward trend, and the economy is holding up.
That said, this rally has been far from smooth. Early February saw an exceptionally strong US jobs report. This was followed by a banking crisis in March, reigniting fears of further interest-rate hikes. The result was an 8% pullback in the S&P 500 Index. Nonetheless, the rally soon got back onto an even keel as investors began to believe that the momentum drive that started back in October would resume – particularly with the Fed's rate-hiking campaign nearing an end.
While a great deal of uncertainty remains, the market swings have been rather benign for much of this year (excluding the March fiasco). Indeed, the VIX index (a measure of market volatility) seems to concur, declining fairly steadily to its lowest level since the March banking crisis.
While Wall Street has been the biggest influence on markets over the first half of 2023, this influence has been skewed by a handful of companies. In fact, forget the old “FAANG” acronym: overwhelming evidence would suggest that this year’s US gains have been driven by the newly-named Magnificent Seven – Nvidia, Tesla, Meta Platforms, Apple, Amazon, Microsoft, and Alphabet. While the S&P 500 Index has registered gains of just over 16% over the first half of the year, the heavily tech-weighted NASDAQ Composite Index has skyrocketed to almost 33% over the same period.
But if this is a new bull market in the making, then it is expected that this rally – which has so far lifted so few stocks and sectors – will broaden out over time to embrace many of the businesses that will benefit from further economic recovery and rising growth prospects. Indeed, the US market is already suggesting this is underway: the S&P 500 Growth Index outperformed the S&P 500 Value Index by just under 15%. Similarly, in June, the US small and mid-cap stocks joined the supposed new bull market.
Compare this with the 30 largest publicly owned blue-chip companies listed in the Dow Jones Industrial Average Index: a lacklustre rally of just under 4% really does reflect the importance of owning technology stocks in those “Magnificent Seven”.
While most investors have been focused on Wall Street, another important bull market has been picking up speed. Japan – the third largest economy in the world behind the US and China – has seen the Nikkei 225 Index climb sharply, rising nine weeks in a row. Interestingly, one person who has been pouring money into this market recently is Warren Buffett. The Japanese recovery has not gone unnoticed by Buffet, and so the Saga of Omaha has been adding to his holdings.
In a bid to benefit from the weaker yen, thousands of Chinese tourists have been flocking to Tokyo and Osaka to eat Japanese food and enjoy Japanese shopping expeditions. Similarly, for many Japanese exporting companies, the weaker currency has made them more competitive, turbocharging their corporate earnings.
Japan is one of the West’s allies in a troubled region. It is home to many of the world's leading companies, including Bridgestone, Canon, Honda, Nintendo, Sony, Toyota and Toshiba. It also boasts an abundance of smaller, exciting companies to consider as investment opportunities for the future.
Essentially, global investors have applauded Japan’s corporate governance changes (announced after rising pressure from domestic and international investors). Japanese management has now had a change of heart, and companies are responding more sincerely to shareholder activism.
The Nikkei 225 Index has settled at its best level in 33 years and has doubled in value since its March 2020 bottom. Indeed, it is up by 27% year-to-date (in yen terms). Unfortunately, since the pound has strengthened against the yen, it equates to far less for UK investors (those who had not hedged their position).
The Nikkei reached an all-time high in December 1989 – just under 39,000. Its subsequent collapse was attributed to disastrous administration and an attempt to deflate investor speculation in order to keep inflation in check (the Bank of Japan raised rates sharply). The ensuing years are now referred to as Japan’s “lost decades”. But the recent euphoria in the market has left the Nikkei just 17% shy of its all-time high, and many market pundits are predicting that after three decades, it will soon be retesting that value.
The recent excitement directed at Japan has been so high that a market pullback, or perhaps some profit-taking, cannot be ruled out. Needless to say, this would constitute an opportunity to buy – or add to – current positions.
What has been disappointing in the last six months has been the reopening of the Chinese economy. China often defies simple market characterisation, but the anticipated economic recovery seems to have been a false dawn – something which over the past thirty years has been more associated with Japan than China. Sadly, judging from the recent Purchasing Managers’ Index data, the impact of this has affected industrial and real estate activity. The commodity sector has also been hit: base and bulk commodity prices are generally down for the six months to the end of June. The softening of current commodity demand from China, falling metal prices and the rapid deceleration in growth prospects over the past quarter have resulted in some of the major mining companies cutting their dividends.
However, certain indicators suggest that sentiment is likely to turn positive soon. For instance, President Xi Jinping's response to China's recent softening growth forecasts, the People's Bank of China cutting interest rates, and the growing need for core and smart commodities over the next few decades (for clean energy and electrifying vehicles) are likely to catalyse a new "commodity super cycle" as demand outstrips supply.
Meanwhile, in the UK, inflation is higher than in any other advanced economy. This is why Andrew Bailey is still somewhat hawkish regarding further interest rate hikes. Most commentators agree that with sticky inflation and wage increases, the Bank of England will have little option but to increase interest rates yet again. Some experts are even predicting a further 50 basis point hike in interest rates next month, with rates peaking at as much as 6% by the end of the year.
As far as the UK stock market is concerned, the FTSE 100 and the FTSE All-Shares indices have registered a meagre 1.07 and 0.52% capital return respectively, for the year-to-date. Meanwhile, a glance at the market cap spectrum of AIM mid- and small caps shows that the indices are all in negative territory year-to-date.
European Bourses have notched up some strong first-half-year gains, despite sticky inflation, interest rate hikes and bank failures. But ECB President Christine Lagarde continues to believe that inflation is still too high and that it is too early to declare victory over consumer price rises. Expect further rate hikes in the central bank’s mission to tame inflation.
Elsewhere in the world, the picture for the Asia Pacific markets was somewhat nuanced over the first half of the year. China's economy got off to a false start, lending costs edged higher, and the US dollar remained fairly resilient, all of which affected market sentiment. Some emerging market regions (Latin America and India) have fared well.
As mentioned above, bulk and precious metals have suffered in recent months, but Brent Crude Oil has performed no better. In fact, Brent Crude futures posted its fourth consecutive quarterly decline amid fears that major central banks may not be done with raising interest rates.
Typically, a strong start to the calendar year is a good sign for the rest of the year. While it may be too early to bank on a repeat of the first-half gains in the second half of 2023, things are beginning to look more bullish.
We have consistently stated that a new bull market started on 12 October 2022. We currently have no reason to believe otherwise. Although the first half of this year's rally has been primarily driven by a small number of mega-cap stocks in the tech sector, we believe that market participation will broaden in the second half of the year.
Furthermore, we think that AI will have far-reaching effects on every business and household over the coming decades… not dissimilar to the way in which the Internet changed our lives some 30 years ago.
