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PORTFOLIO COMMENTARY

The Innovation Portfolio got off to a solid start in 2023 generating a return of +16.2%. In comparison the S&P 500 and the Russel Small Cap Index (which serves as the benchmark) returned 7.0% and 10.4% respectively. 

The strong outperformance was on the back of falling inflation and inherently, a light on the horizon that might signal the peak in the interest rate cycle in the US.

 

The Macroeconomic Summary

In January, markets rose as investors thought they had a good understanding of the inflation and interest rate dynamics to come. That view entailed ongoing disinflation with an imminent peaking in interest rates and some monetary policy easing in the latter part of the year. The clarity of understanding gained in January was instantly replaced at the onset of February with a view of sticky inflation and higher interest rates that would extend well into the next year.  

The markets balked at this new notion and gave up a measure of their January index gains in February.

It turned out that the rapid rise in interest rates, designed to reduce inflation back to target levels, had other ramifications. Some poorly managed mid-size banks in the US found themselves in trouble as depositors, sniffing a bank collapse, rushed for their cash. The Federal Reserve Deposit Insurance Company was forced to quickly intercede to protect depositors as Silicon Valley Bank became the second largest bank failure in US banking history and Signature Bank became the third largest.

As March progressed, investors became a little more comfortable with the banking sector after visible support by the fiscal authorities. There was also the belief that measures taken after the Global Financial Crisis in 2008/09 to improve the integrity of the global financial system would prevent a repetition of those events. The dilemma that central banks faced at their March meetings was whether to continue hiking interest rates in an environment of unacceptably high inflation or ease up on their tightening in the face of a potential banking crisis and possible credit crunch. As it turned out, the big central banks didn’t flinch. They stressed that the banking sector was safe, and that inflation remained public enemy number one. The Federal Reserve hiked rates by 25 basis points, the European Central Bank hiked their policy rate by 50 basis points and the Bank of England moved the bank rate up by 25 basis points.

The markets continue their standoff with the central banks, taking the view that interest rates would not go up much more and won’t need to stay elevated for long. The US equity market is thumbing its nose at the Federal Reserve and the market strength is an indication that investors believe that the first interest rate cut will be earlier than Jerome Powell and his Federal Open Market Committee colleagues are suggesting.

Click here to access the full report.

About the Author

Wouter Van Der Merwe
Portfolio Manager, Sasfin Wealth

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