Quarterly Investment Update

Following a strong first half of the year, global markets suffered losses in Q3 as investors came to grips with the increased chances that global central banks will need to maintain interest rates higher for longer time.

The US economy continued to show resilience in the face of the most aggressive tightening cycle in decades. The labour market remained tight and the country’s GDP expanded by 2.2% in Q2 supported by increased consumer spending and business investment. This, in combination with retreating inflation fuelled bets that the Fed will be able to successfully bring down inflation without harming the economy, with investors moving away from their recessionary expectations towards a soft-landing scenario. However, the strong labour market and a resurge in energy prices continue to pose a risk on inflation which came in at 3.7% in August, exiting expectations, due to higher costs for rent and fuel, underscoring the need to keep interest rates higher for longer. In September, the Fed decided to pause its tightening campaign following a 25bps hike in July, but reiterated its commitment in fighting inflation. As a result, expected long-term interest rates were adjusted upwards wiping out US government bonds’ YTD gains. A surge in bond yields was further supported by 1) lower demand from foreign investors, 2) tightening of Fed balance sheet, and 3) increased new debt issuance after the Treasury signalled greater borrowing needs. Equity prices were also affected with the S&P 500 dropping by -3.7% in Q3, decreasing YTD gains to 11.7% while the USD strengthen by 3.2% vs peers. At the same time, Fitch downgraded US rating to AA+ from AAA siting the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance. This however is not expected to deter the top-notch status of US assets over the longer-term given the lack of alternatives and the economy’s solid growth.

Unlike the US, the eurozone’s economy has started to feel the impact of the tighter monetary policy. Economic data out of the eurozone have painted a grim outlook with Germany expected to shrink by 0.4% this quarter, while eurozone’s economy grew by just 0.1% in Q2. Eurozone’s inflation eased to 4.3% in September, but policymakers signalled that interest rates will need to be kept high for a long period of time amid growing concerns surrounding higher energy prices. While ECB delivered two more 25bps rate hikes in July and September, President’s Christine Lagarde’s remarks struck a dovish tone with investors as she talked about the area’s deteriorating economic outlook and causing the euro to depreciate by 3.1% vs the dollar, reversing its YTD gains to losses. European equities lost -5.1% over the third quarter bringing YTD gains down to 10.04%, further weighted down by weak Chinese data while geopolitical risks continue to weight in the region.

Swedish equities lost 6.7% in Q3 bringing YTD gains down to 5.5%. Households have been particularly hit by the central bank’s tightening campaign as the higher interest rates have quickly translated into people’s mortgage payments which are only fixed for short-term periods. This has been evident from declining consumer confidence and shrinking economy, plummeting housing construction and a sharp slowdown of lending. The real estate sector continues to pose a risk as highly leveraged real estate companies need to refinance their debt at higher rates and have seen their credit ratings downgraded. While inflation has shown signs of cooling down it is still above the central bank’s target who faces the difficult choice between supporting the struggling economy or keeping rates tight to avoid further devaluation of the Swedish currency which in turn puts upward pressure on inflation. The currency reached new record lows against the EUR during Q3 but eventually reversed losses and appreciated by 1.85% following the central bank’s decision to start selling USD and EUR reserves for SEK as part of a program to hedge FX reserves against a recovery in SEK.

In UK, equities were up by 2.1% in Q3 as the British sterling lost 3.97% vs the USD. The FTSE 100 index tends to rise as the pound drops as many of its companies measure their revenues and profits in dollars. In addition, higher crude oil prices supported the index’s energy stocks. The Bank of England left interest rates at 5.25% in September’s meeting after inflation in August came in lower than expected at 6.7%. Consumer sentiment improved in September as wage growth started to outstrip inflation, easing a cost-of-living crunch on household finances.

Stocks in Asia fluctuated and Chinese shares were back in the red losing 4.3% over the quarter. Unlike most economies that suffer from high inflation, China is facing deflationary pressures amid economic growth weaknesses. While this allows the People’s Bank of China to provide monetary support to the struggling economy, the central bank is facing several constraints that’s making it cautious, such as a weaker yuan and elevated debt levels in the economy. According to surveys, China will just about meet its economic growth target of around 5% for this year, but the ongoing property crisis is raising the risk of a miss. Worries about the real estate sector resurfaced after Country Garden missed two coupon payments on its bonds and following news that China Evergrande Group had cancelled a creditor meeting. Elsewhere, the Bank of Japan held to its ultra-low interest rates and maintained its pledge to support the economy, suggesting no shift in its massive stimulus program is coming. The yen dropped against the dollar after the decision.

Crude oil prices surged in the past three months by extending a powerful rally that may rekindle inflation, as increased global demand and tighter supply amid output cuts by OPEC+ have driven prices up by 28.5%. Gold lost about 3.7% in the third quarter reversing its YTD gains as falling risks of US recession and higher long-term interest rates drove safe-haven seekers out of the market.