Quarterly Investment Update

Global stocks continued their upward trajectory in the second quarter defying bearish market expectations even as central banks worldwide remained fixated on tightening interest rates to fight inflation.

Strong guidance from the Artificial Intelligence space fuelled a surge in technology stocks that lifted US equities up. Specifically, mega-cap tech stocks steered the S&P 500 performance of 8.3% in Q2, which is now up 15.9% over the year. The Nasdaq index appreciated by 12.3% with the tech-heavy gauge jumping 31% since the start of the year, its best first half of the year since 1983. Equities were further supported by strong economic data and better than expected company earnings in Q1. During the quarter, markets had to navigate through the largest bank failure since the 2008 financial crisis after First Republic was seized by regulators and sold to JPMorgan and the US debt ceiling negotiation that raised the probabilities of a US default. However, as regional bank outflows finally stabilized and the US government reached a last minute debt ceiling deal, investors once again turned their attention back to inflation and interest rates. While inflation cooled down to 4% in May, recent data on consumer spending and unemployment highlighting the resilience of the US economy seems to be supporting the case for keeping interest rates higher for longer. In addition, a revision of Q1 GDP revealed that the economy grew by 2% instead of initial estimates of 1.3%. The above alleviated US recession fears, and markets appeared to be taking the Fed’s guidance of no rate cuts in 2023 more seriously. The Fed raised interest rates by 25bps in May and paused its rate hiking campaign in June as largely expected. Investors have now shifted their interest rate expectations upwards, pricing another rate hike in July and are no longer expecting any rate cuts in 2023, driving bond yields up and bond prices down.

European stocks were up 3% in Q2, held back by uncertainty over the strength of China’s economic rebound and shifting interest rate expectations. The EUR initially suffered some losses against the USD during the US Debt ceiling crisis, but managed to recover, ending the quarter up 0.65% vs the USD following hawkish remarks by ECB officials. The ECB delivered two rate hikes of 25bps in May and June respectively, and warned that the hiking cycle would continue until it was clear that inflation would come down to its 2% target. Despite a significant fall in euro zone’s inflation to 5.5%, the ECB raised its inflation projections for the next years as prices on core components remained elevated. Unlike the US, recent readings out of the euro area seem to suggest that the higher interest rates have started to impact the real economy. An ECB survey showed that banks have significantly tightened access to credit, which could further dampen eurozone’s growth which came in weak at -0.1% in Q1. Germany has seen a strong fall in industrial production, falling consumer sentiment and entered into a recession in Q1 by contracting for the second quarter in a row. For now, sluggish eurozone activity hasn’t harmed its labour market much, with worker shortages also helping support a quick rise in pay in recent wage deals.

Stubbornly high inflation continues to pose a headache for UK policymakers as it remained put in May at 8.7%, surpassing forecasts. In response, the BoE surprised markets and delivered an outsized 50bps hike in June, underlining policymakers’ determination to combat inflation. Mortgage lending plunged to mid-pandemic levels as the high interest rates depressed buying interest in Britain’s real estate sector. Short-term borrowing costs climbed above 5% for the first time since the global financial crisis and the sterling rose by 3% against the USD. In the midst of the above, the FTSE 100 lost 1.3% over the quarter.

In unwelcome news for Riksbank, the Swedish Krona continued to spiral reaching a record low against the EUR and further complicating the central bank’s fight against inflation which despite slowing down to 9.7% in May, is still much higher than the central bank’s target. The currency was weighted down by a combination of global risk aversion and expectations that the central bank is close to wrapping up its yearlong interest-rate hiking cycle which has been particularly harmful to Sweden’s households where mortgages rates are typically fixed for only three months, and to a number of Swedish property groups that have seen their ratings dropped from investment grade to high yield as they must refinance more than $40 billion of maturing bond debt over the next five years. Bankruptcies rose by 31% in June as interest rates reached the highest level in nearly 15 year after Riksbank hiked rates by 75bps in Q2 and warned of another hike. In spite of the above, recent economic data have been robust, with employment holding up and retail sales increasing while equities rose by 3.9% in Q2.

Chinese equities suffered losses of -7.8% over the quarter wiping out its YTD gains to -4.2% in 2023 on the back of muted domestic demand and signs that the world’s second-largest economy is struggling to rebound, bolstering calls for more policy support. While People Bank of China did reduce interest rates, banks lowered interest rates by less than expected while policymakers failed to provide any tangible evidence to support any potential stimulus or its timing. The above unnerved investors who had bid up Chinese equities in the hope of a sweeping package that would support infrastructure and the ailing property market. On the contrary, Japan’s Nikkei index rallied by 18.4% in Q2 bringing YTD gains to 27.2%, on optimism that the world’s third-largest economy will outperform peers. A renewed push by Japan’s corporates to increase buybacks and focus on returns is helping boost sentiment, while better-than-expected economic growth, easy-money policy and further easing of pandemic regulations boosted consumer spending. The Bank of Japan kept its negative rate and yield curve control program unchanged as Tokyo’s core consumer inflation rose to 3.2% in June, below 3.3% forecast. As a result, the Japanese yen depreciated by 8.6% vs USD as expectations for continued divergence between the Bank of Japan and the Fed are keeping a lid on the currency, which in turn helps Japanese stocks.