July market commentary

July 2023 Market Commentary

We hope you are keeping well and are enjoying the warmer conditions, along with the seasonal festival and sporting indulgences. Perhaps moods would be euphoric but for the cursed menace of inflation. The policy response from the Bank of England seems intent to drive a recession into our economy, culling demand and curtailing price hikes. It is difficult to look past this gloom, however, the UK is something of an outlier relative to the rest of the world, nor is it the dominant force in global equity and bond markets. Indeed, such is the global nature of our domestic stock market that UK economic performance isn’t the dominant for most UK shares either.

On this very point we note global stock markets recaptured their momentum in June, ensuring it was a positive second quarter and rounding out a strong first half of the year. Such performance has confounded the market consensus, with the most common narrative anticipating a weak first half of 2023 and a recovery in the second. This ‘consensus’ centred upon growth concerns entering 2023, following the rapid increase in interest rates witnessed in 2022. Such fears were misplaced, however, as a strong labour market and high levels of savings combined to keep consumers active – particularly within the service sectors of the economy. The forestalling of a recession likely lifted downbeat sentiment therefore, and with it, share prices.

With inflation remaining stubbornly high, however, the interest rate environment looks set to remain ‘restrictive’ for some time to come. And so, whilst a recession might be ‘delayed’, it is hard to envisage one being ‘denied’; with the situation looking increasingly perilous in the UK.

Investors should brace themselves for further volatility on this basis, but we would again argue all may not be lost for equity investors in such a setting. A recession that seems so widely predicted may not inflict the same damage as one that catches investors off-guard. The recession may not be so severe either, given the apparent absence of major economic imbalances i.e. corporations and households don’t (in aggregate) appear to be shouldering quite so much leverage as in prior, more devastating recessions. We should also remind ourselves that having moved off the zero bound, there are now interest rates to cut! Again, this policy flexibility might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm. A recession that arrives in 2024 also offers additional time for inflationary pressures to recede; affording Central Banks the option to take a more assertive dovish stance than if a recession were to hit sooner and with inflation still riding high.

As you will likely be aware, something of an ‘Artificial Intelligence’ frenzy has also gripped markets this year, as evidenced by outsized performance from a handful of large US Mega Cap tech names. Investors must be alert to the perils of missing out on any such ‘mania’ on the way up, but also participating on the way down. On balance, portfolios remain committed to the US Growth sector and, therefore, will have some exposure to this A.I. theme, as part of an appropriately diversified portfolio.

An A.I. led productivity boom may be a distant prospect but markets can look a long way ahead; particularly as wage inflation remains such a troubling force and A.I. offers a solution. Of course, the timing of any such outcome could well disappoint, hence the insistence to diversify portfolios appropriately from a sector, regional and asset class perspective.

There are other reasons beyond A.I. to believe the equity market rally can continue, however, not least the potential for abating inflation; conceding the probability seems more likely internationally than at home. Weaker energy prices, healing supply chains, soft housing markets and potentials cracks in the (still firm) labour market could be the catalyst for this moderation; and one which would point to a sooner end to interest rate hikes. The fading prospect of a banking crisis could continue to lift sentiment too, and with surveys suggesting investor cash levels remain pretty high, fear of missing out could also play a role.

Recognising the outlook remains uncertain, however, as well as our philosophical belief in the need for humility when investing, we strive to seek appropriate levels of diversification to meet the investment challenges ahead. Relative to stocks for example, high quality corporate and government bonds might offer a more defensive return profile in the face of less encouraging growth outcomes, particularly given the increase in yields observed over recent months. Alternative asset classes also help diversify portfolios in a more troubling period for stock markets.

Kind regards,

iPensions Wealth Team


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