Global equities enjoyed a positive start to the year as the MSCI All Country World Index, returned 7.3% during the first quarter of 2023. Market participants have grown increasingly confident that the US Federal Reserve’s (“Fed”) rate hiking cycle will soon come to an end. Factors supporting the market’s current view include the continued deceleration in inflation levels as well as the recent turmoil in the banking sector.
Evidence continues to suggest that inflation in the US has peaked, as the annualised US CPI level fell from 7.1% in November of last year to 6.0% in February. Core inflation, which excludes pricing changes in energy and food, decelerated from 6.0% to 5.5%. Despite the downward trend, high levels of inflation are still proving to be somewhat sticky and many Fed officials continued to voice their support for further rate hikes.
That was until the emergence of the recent banking turmoil, complicating matters for the Fed, as well as other central banks. To date, two mid-sized regional US banks have failed, a third was on the brink of failure before intervention from other large US banks and Swiss authorities forced ailing Credit Suisse to merge with its bitter rival UBS to prevent the banking giant from an almost certain collapse. There are a number of reasons that led to depositors fleeing and trust evaporating for the banks but the rate hiking by central banks certainly played its part. Further rate hikes could lead to additional strain in the sector, resulting in even more banking casualties, giving central bank officials reason for pause on future increases.
The bond market seems to believe that at this point, the rate hiking cycle may be coming to an end as evidenced by the fall in longer-term bond yields. The US 10-year benchmark fell close to 40 basis points as it ended the quarter at 3.49% and the US 10-Year real interest rate, which strips out inflation, fell slightly more than 40 basis points to end the period at 1.16%.
Long duration stocks, those whose cash flows lie further out into the future such as growth stocks, benefitted from the fall in longer-term yields. Technology stocks generally possess a growth tilt thus accounting for the strong gains in the Information Technology sector as well as the Communication Services sector which includes Big tech names such as Alphabet, Meta, Netflix and Tencent. Similarly, the Consumer Discretionary sector includes technology-like counters that benefitted from lower interest rates such asAmazon, Alibaba and Tesla (for those that consider the EV maker “tech-like”).
Gains in growth stocks came at the expense of stocks that are more value-orientated, specifically those that are less volatile and more defensive in nature. This is evidenced by the quarterly underperformance of the Consumer Staples, Health Care, Real Estate and Utilities sectors.
Financials also underperformed during the quarter as the emergence of a potential banking crisis dragged the sector down. The fallout from the banking sector spilled over into oil markets with some fearful that a banking crisis could result in declining economic growth, leading to lower oil demand. Both Brent crude and WTI fell to around the $70 a barrel level before recovering somewhat to close the quarter out at $80 and $76 a barrel respectively, still below their opening price levels at the beginning of the year.
One commodity that has reacted positively to the banking sector jitters is gold. Fearful over the stability of regional US banks, many have piled into the safe haven hard currency asset, briefly pushing its price above $2,000/oz, whereafter it pulled back slightly to close the quarter at $1,980/oz. Bullion does not offer a yield and therefore the recent fall in real interest rates has also added to its allure.
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