November provided investors a strong set of returns as stock and bond markets reacted to a growing expectation that central banks are not only at the end of their cycle of increasing rates, but that decreases will start to occur from the middle of next year. The MSCI World Index posted its strongest month in three years in US dollar terms and although this was pared for UK investors due to a move higher in sterling, monthly returns were still over 5%.
A combination of dovish central bank rhetoric and favourable economic data over the past month has led to the consensus narrative of more supportive monetary policies going forward. 2023 was expected to be a challenging year for economies and financial markets as the impact of the rapid increase in interest rates took its toll, but, barring anything dramatic in the coming weeks, its largely turned out better than expected.
Economic data and corporate results have surprised to the upside on the whole, albeit significantly aided by a lowering of the bar due to pessimistic forecasts. Generally speaking, the latest set of economic releases point to gradually slowing, but still growing, economies and falling price pressures – a mix favourable for investors hoping for so-called immaculate disinflation. Risks remain but a soft landing scenario is now being seen as a real possibility after being dismissed by many this time last year as little more than a case of wishful thinking.
The US and Eurozone have both made strong progress on inflation, with the latest core personal consumption expenditures (PCE) price index – believed to be the Federal Reserve’s (Fed) favoured inflation measure – coming in at 3.5% year on year and the Eurozone consumer price index (CPI) falling to 2.9% in annual terms. The situation in the UK is not quite so good but there has been substantial progress nonetheless, with the most recent CPI falling to 4.6% year-on-year, well under half of its peak in late 2022.
Inflationary concerns due to energy prices are often heightened during winter but despite the ongoing war in Ukraine and the conflict in the Middle East, there has been little sign of a forthcoming substantial escalation in prices so far. The oil price declined again in November and Brent crude, the international benchmark, fell below US$80/barrel to trade towards the lower end of its range over the past two years.
The sterling to US dollar exchange rate appreciated by almost 4% in November, due to more stubborn inflation and a relatively stronger set of economic data. As a result, the Bank of England (BoE) are maintaining more hawkish language in their communications than US and Eurozone counterparts, with governor Andrew Bailey stating “we are not in a place now where we can discuss cutting interest rates”. Despite this, interest rate markets believe the BoE will be not far behind the Fed in lowering rates in the middle of 2024.
UK stocks rose by 2.3% last month, a solid return but underperforming peers across the Atlantic and the Channel. The MSCI Europe ex UK benchmark gained 6.5% while the MSCI North America index tacked on 5.4% – both in sterling terms. Broad-based gilt benchmarks gained 3.1% in November, with the long end of the curve (15 year+: 5.6%), index-linked (3.6%) and corporates (3.5%) all outperforming. US Treasuries rallied strongly for one of their best monthly gains in decades, however for UK investors this was offset by the currency move.
Conclusion
In summary, so far 2023 has been a pretty good year for investors and returns have been better than many expected. It’s worth pointing out that this has not occurred against a backdrop of a roaring global economy and a thriving business climate, third quarter US GDP growth of 5.2% annualised and the burgeoning Artificial Intelligence (AI) industry notwithstanding. It has more been a story of the overly pessimistic expectations coming into the year meaning that the avoidance of bad scenarios has actually been cheered by investors.
There have even been unforeseen shocks such as the recent outbreak of war in the Middle East and the US regional banking crisis in the first quarter, but the weakness these events brought about actually turned out to be attractive buying opportunities.
Looking ahead we expect growth to slow further as the impact of restrictive monetary policy takes a further toll. The focus is now very much on when central banks pivot. As key interest rates in the UK, US and Eurozone are now significantly above inflation measures, the real interest rate is firmly in restrictive territory and therefore could be reduced without providing an expansionary pulse that would threaten to spark another surge in inflation.
Going forward drops in inflation will be harder to come by due to base level effects fading and we are watching closely for signs of how keen central bankers are to reduce gauges back below the 2% target, or whether they will accept slightly higher readings to support the economy. Within the next 12 months we will almost certainly see US and UK elections and any surprises in these has the potential to cause a large market impact.
