- Media Centre
Weekly Market Report
4 April 2023
Looking at Quarter 1 2023.
Service to Clients.
Global and Local Indicators.
Global Report: Looking at Quarter 1 2023
By Nick Downing
The year got off to a good start for global financial markets, building on the rally which began in October when investors detected the world had moved past the point of peak inflation, peak bond yields and peak central bank hawkishness. China’s sudden reopening from Covid restrictions added to optimism. China is forecast to achieve 5.5% growth in 2023 compared with 3% growth in 2022, as pent-up demand boosts consumer spending. It is the world’s second largest economy, so its dramatically improved growth prospects have a positive ripple effect for global growth. The easing of China’s supply chain disruptions also helps reduce global goods shortages and goods price inflation. Europe emerged from its energy crisis relatively unscathed, helped by government subsidies and a sharp decline in gas prices, which fell below levels that preceded Russia’s invasion of Ukraine. The US economy also surprised to the upside, with a buoyant jobs market and substantial savings reserves accumulated from pandemic handouts helping households withstand sharply higher interest rates.
The global rally paused in mid-February after stronger than expected US inflation data. US CPI had been on a steady downtrend since peaking at 9.1% in June, allowing the Fed to temper its interest rate outlook. However, January’s CPI data was disappointing. Year-on-year (y/y) headline CPI slowed only slightly from 6.5% to 6.4%. Month-on-month (m/m) it increased by 0.5% compared with 0.1% in December. Core inflation, which excludes food and energy, did not fare much better, reducing only slightly y/y from 5.7% to 5.6% and m/m remaining at 0.4% unchanged from December’s figure. In the UK, inflation also suffered a setback. February CPI increased to 9.2% y/y from 8.8% in January.
Investor sentiment soured further after the rapid collapse of Silicon Valley Bank on 10th March, which set off a rapid withdrawal of deposits from other regional banks in the US. By the following weekend, contagion spread to Europe leading to the rescue and forced takeover of Credit Suisse. However, authorities moved rapidly to prevent a full-blown financial crisis, with ample deposit guarantees and liquidity injection in the US, while the Swiss National Bank provided a credit line to Credit Suisse before arranging its takeover by its banking peer, UBS.
Yet, most equity markets ended the quarter in positive territory. Europe provided the best returns, helped by historically low valuations, lifting the German Dax by 12.3%. Cheap valuations also helped Japan’s Nikkei 225 index with a gain of 7.5%. The US benchmark, the S&P 500 index increased by 7.0% but the UK’s FTSE 100 lagged with a gain of 2.4%, undermined to some extent by the pound’s appreciation. In China, the Shanghai & Shenzhen CSI 300 index built on its powerful Covid reopening rally with a further 4.6% quarterly return. Overall, the MSCI Emerging Market index returned 3.5% while the MSCI World index increased by 7.3%. The all-important 10-year US Treasury bond yield offered valuation support to equity markets by edging lower over the quarter from 3.88% to 3.49%. A slightly weaker US dollar also lent support to market sentiment. The dollar index lost 1% from 103.25 to 102.51 in anticipation that the Fed will end its policy tightening sooner than the other major central banks.
Bank failures so far have been idiosyncratic, caused by poor management rather than systemic imbalances. SVB’s failure was due to losses incurred on its portfolio of US Treasury bonds rather than credit defaults. Defaults are generally at low levels. The debt servicing capacity of households and businesses is healthy, helped by steady deleveraging of private sector balance sheets across the US and Europe since the 2008/09 Global Financial Crisis. As a result, non-performing loans are at historically low levels. Moreover, bank balance sheets have steadily improved over the past 15 years, guided by rigorous stress tests. Banks are much better capitalised, loan to deposit ratios are very low, and in the US the banking industry’s reserve coverage ratio is at its highest in 40 years. A system-wide crisis is unlikely.
The greater concern is the impact that an ensuing tightening in lending standards might have on economic activity. Tighter lending standards would choke off credit extension, but solid bank capital adequacy and reserve ratios should limit the impact. Economic activity was on a rising trajectory prior to the bank failures so could accommodate a slowdown without resulting in recession. The OECD predicts 0.5% quarter-on-quarter global GDP growth in the first quarter (Q1) a sizeable improvement on the 0.2% contraction in Q4 last year. The global composite purchasing managers’ index (PMI), which measures forward looking economic survey data, has steadily increased since the start of the year, rising in February to 52.1, above the neutral 50-threshold for the first time since July last year. Gains were recorded across most major economies. New orders readings indicate further improvement ahead. The March US composite PMI surveyed two weeks after the banking sector turmoil began, unexpectedly jumped to 53.3 from 50.1 in February. In its latest policy meeting on 22nd March, the Fed trimmed its 2023 GDP growth forecast but not by much, from 0.5% to 0.4%.
Bank failures are par for the course when interest rates increase. The good news is that they tend to mark the end of rate cycles. The end of the rate hiking cycle is now in plain view in the US, with other central banks unlikely to be far behind. At the Fed’s March policy meeting, Chair Jay Powell said tighter bank lending standards may well do the Fed’s job for it, “in a way that substitutes for rate hikes.” The futures market points to a falling fed funds rate, which had been projected at the start of March to rise to 5.7% by mid-year from its current level of 4.75-5.0% but is now projected to drop to 3.8% by year-end. There has also been a constructive decline in the 10-year Treasury bond yield, the benchmark for valuing financial assets worldwide. This is all good news for financial markets, with a recent surge in central bank liquidity providing added impetus. The Fed’s balance sheet gained by a massive $300 billion in the week following the SVB collapse, a rate of liquidity expansion not seen since March 2020 at the outset of the Covid pandemic. More liquidity expansion is predicted, which should feed through to higher financial asset prices.
According to independent research company MRB Partners: “The global economy didn’t need any help, but just received lower borrowing rates, a reversal (for now) of some of the paper losses on government bonds, lower energy prices and a near certainty that the Fed et al will not deliver a monetary knock-out blow for the foreseeable future.”
Inflation will edge lower over coming months, helped by falling energy and goods prices, and helpful base effects. In the US, the moderation in shelter inflation, which has an outsized weighting in core CPI measures, will also be helpful. At the same time, the monetary outlook is improving, which combined with continued economic growth points to a reasonable backdrop for equity markets, especially in faster growing regions including China, the Far East and Europe. Equity valuations are also more attractive in these regions, relative to their own long-term averages and especially, relative to the US. The UK economy has weak prospects compared with other developed economies, stemming from a lack of progress with new post-Brexit trade agreements and an over-leveraged property market but its equity market more than compensates, valued about 25% cheaper than its long-term average. Moreover, a substantial portion of UK equity earnings are generated offshore, so benefit from a weak currency.
The recent bank turmoil masks the progress made over the past year towards normalising inflation, and the adjustment from abnormally low interest rates and excessive equity market valuations. Although inflation is still well above central bank targets, it is gradually declining and interest rates, bond yields and equity valuations have normalised over the period. Although risks remain, as they always do, there is now value in the market and therefore a considerably greater margin of safety for investors with better prospects for investment gains.
Local Report: Service to Clients
By Bradley Murray
INTRODUCTION: I have been asked to write a piece on “Service to Clients” because I have been told it is one of my strengths and something that I excel in. I almost feel like Jerry Maguire (played by Tom Cruise) in the like-named Oscar-winning movie, when he writes his mission statement and his belief that a client should not be a number.
Truth be told, everyone can provide great service to their clients. All it takes is a genuine desire to care about people, their lives and the things that are important to them and make them “tick”. Are your clients simply a means to an income or are you genuinely interested in their lives and ultimately their happiness. Obviously, in our industry, it is a great responsibility to manage clients’ pensions, investments and in some cases their life savings.
For me however, providing service to my clients is about serving them and their needs and not just simply meeting their requests. Most of my clients have become more to me than just simply a person that needs to be serviced on a quarterly basis. Yes, I do have some clients that simply like to have me provide investment guidance, but all my clients know that if they need anything they can contact me at any time, and I will be available to assist them.
KNOW YOUR CLIENT (KYC): Financial consultants are now, more than ever before, required to know their clients. It has been part of my methodology for many years. I stay close to my clients. I make a point in personally giving all my clients a call each quarter to discuss any concerns they may have about their investment and to simply catch up on their lives outside of a general investment discussion and if necessary, I pay them a visit. This I believe is a more genuine approach rather than my clients always thinking I just want to sell them something or invest more of their money. Recently my clients have started referring their children to me for guidance. As a parent of my own children, I would never refer my children to anyone I do not trust, and this is happening since I am more attentive in my clients’ lives than just their wealth.
A LIGHTBULB MOMENT: Sometime back I had a lightbulb moment when sitting and considering my responsibilities to my clients. I realised that although I work with people’s money, I am in essence managing pieces of time that represent people’s lives. Time, they spent working hard, often far away from loved ones or the things they enjoy, in order to build a future. This is time that can never be recovered. The truth is that essentially the wealth we work with represents large parts of people’s past that they will never get the opportunity to relive, or contribute to, again. Not only are we working with wealth generated over our clients’ lifetimes but also the legacy of future generations. So, if we do not get this right, it can affect not only our current clients’ wealth, but also the future generational wealth that will be transferred to their children and potentially their grandchildren.
TREAT THE CLIENT FAIRLY (TCF): It is mandatory for financial consultants to Treat Clients Fairly. I have been a TCF fanatic since day one. It is our responsibility to clients to be honest, responsible, and truthful in our actions towards them and their investments, and to shed light and understanding in a way that gives them confidence in our ability as their investment advisors and portfolio management team. Service to me, really means enjoying what you do and caring about the people you do it for. If you embrace the people you serve and get to understand and love them, then serving them will never be hard. Service also means being there to talk to your clients when things are great, but more importantly when things are not so great, such as the market turmoil that clients have faced over the last two years with market performance being incredibly volatile.
BOTTOM LINE: KYC and TCF comes naturally to me – I have always been ahead of the curve. Financial consultants must pay due regard to the needs of their clients and communicate with them in a way which is clear, fair, and not misleading. Jargon must be avoided. It is easy to copy a product – especially a financial product. But service excellence is almost impossible to copy. The consultant providing the best service wins. Back to Jerry Maguire’s mission statement – a client should not be a number – a client should always be number one. If you are interested in experiencing excellent financial service, please contact one of our friendly consultants. They will take the sting out of investing.
The Bottom Line: Innovation and the Magic of Compounding
By Carel La Cock
The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.
Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.
After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.
Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.
As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.
Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.
Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.
Spend some time with our team to find out which one of our portfolios is best for you!