The argument that 2023’s strong market gains are solely driven by a handful of US technology giants is starting to crack.
About 80% of the S&P 500 index delivered better sales in the second quarter than analysts had expected. All 11 industry sectors in the US were up in July.
Still, profits are down on last year – at the moment they’re averaging about 5% lower – so it’s not all rainbows.
Still, stocks have done well, with the MSCI World index up almost 20% in the first seven months of 2023. That’s one of the best six months going back to before the great financial crisis.
We’ve responded to this year’s punchy uplift in stock prices by selling down stocks that have done very well, and bolstering our cash. This money earns a decent return now interest rates have normalised, while at the same time reducing risk.
We don’t want to overegg this – this is a slight ‘tactical’ adjustment on our part in response to a short-term change in circumstances. This month, we trimmed e-commerce giant Amazon, American recycled decking manufacturer Trex and plumbing supplier Ferguson.
We bought more government bonds, as yields are attractive, and these ‘safe-haven’ assets should offer us protection in a stock market downdraught. Specifically, we added to the UK treasury 0.875% 2033.
Higher interest rates have also made structured products more enticing. We bought a Credit Agricole FTSE 100/S&P 500 Autocall structured product. This is a contract with an investment bank which matures and pays us a 13% coupon if, in a year’s time, both the US and UK stock markets are above the level at which we bought in.
If one or both are in the red, the autocall doesn’t pay out but rolls the coupon payment into the next year. This continues until both indices finish a year above their trigger levels or the contract’s final maturity in 2028.
If, in five years’ time, both indices haven’t fallen more than 35%, then we are paid 65% (13% for each year). However, if one or both indices have fallen more than 35%, we suffer capital losses in line with the market.
One other point to make here is that the MSCI World is up 20% in dollars – it’s only gained half that in sterling. Since Brexit and its quixotic aftermath sent sterling tumbling, we have hedged much of our dollar exposure to protect against a resurgence in the pound eroding the value of our overseas investments.
That has meant we missed out on some further offshore gains as the pound went lower still, but it has protected us from quite a bit of volatility. This hedge has helped us considerably in the past six months, as we have received returns without the currency handbrake. We have since reduced our hedge now that sterling has returned to roughly the middle of its post-Brexit trading range.
We think the US Federal Reserve has now reached the end of its interest rate hikes, barring a reacceleration in core inflation (which excludes energy and food costs). However, unlike some other investors, we believe rate cuts in the next year or so are very unlikely.
Unless the bottom falls out of the American economy and unemployment rises rapidly, we think the Fed will simply keep its rates flat at a relatively high level for a long time.
As for the UK, it’s a harder situation to assess. The Bank of England (BoE) increased its benchmark rate by 25 basis points in early August to 5.25%. It’s far from clear that the central bank’s whiplash-inducing interest-rate Tower of Terror is having an effect on inflation that has been driven overwhelmingly by soaring prices for electricity and gas.
Inflation is falling now as energy cost spikes fall out of the numbers, yet wage growth is high and core inflation is still almost 7%.
The BoE seems compelled by public opinion to be seen to be doing something – anything – to get inflation down, rather than stand firm on the reality it takes about two years for interest rate changes to truly hit an economy.
We’re concerned that the UK is fragile even before the extremely aggressive interest rate increases bite this year and into the coming years. Hopefully the BoE agrees with us and calls it quits soon.
David Coombs is lead fund manager on the Rathbone Multi-Asset Portfolios
