Economic & Market Overview
• After excluding food and energy, inflation continued to rise, dampening hopes of a pause in central bank rate hikes.
• The higher interest rate environment triggered the collapse of two US regional banks.
• Technology and consumer discretionary stocks outperformed, whilst energy stocks and financials lagged, a reversal from last year.
Equity and bond markets made positive returns over the quarter despite the emergence of stresses in the banking sector, with the recent
sharp increases in interest rates triggering the collapse of two US regional banks. Emerging Markets, having outperformed Developed
Markets at the start of the period following the relaxation of Covid controls in China, gave back some of their outperformance as major
developed central banks stuck to their guns, continuing to raise interest rates in the face of stubbornly high inflation, despite the banking
sector turmoil. Technology and consumer discretionary stocks were the clear outperformers by the end of the period, whilst energy stocks
and financials lagged, a complete reversal from last year. Within Fixed Interest (FI), the defensive characteristics of government bonds were
in evidence once more during the worst of the stresses within the banking sector.
The year started positively. China relaxed Covid restrictions much more swiftly than anticipated, whilst data suggested that inflationary
pressures had peaked, the latter raising hopes that the interest rate hiking cycle was near, or at, its end. These hopes caused equity and
bond markets to rise. Emerging Markets (EMs) outperformed Developed Markets, whilst technology and consumer discretionary stocks
staged a recovery after last year’s brutal sell-off.
However, subsequent data disappointed, and excluding food and energy, inflation continued to rise, dampening hopes of a pause in further
rate hikes, as the US economy, and the labour market in particular, showed little sign of slowing down. The threat of further monetary
tightening took some of the shine off US and EM equities midway through the period, as well as FI markets, although European and UK
equity markets bucked the trend, as a sharp fall in natural gas prices helped to alleviate recessionary fears.
The calm start to the year was shattered as Silicon Valley Bank, a relatively new and fast-growing US regional bank, became the most
prominent casualty of the rate hiking cycle so far. Having suffered a staggering $42 billion of deposit withdrawals in just one day, the bank
folded. The fear of contagion took another regional US bank, Signature Bank, down with it, before the authorities stepped in, promising to
cover all depositors. However, the fear spread elsewhere, bringing back memories of the 2008 financial crisis, as depositors started to flee
Credit Suisse, a relatively well capitalised but historically mismanaged Swiss bank. A swiftly arranged takeover by another Swiss bank, UBS,
brought calm back to markets, with investors being reassured that the banking sector is much better capitalised than it was in 2008, and
has not generally been at the heart of any recent exuberance in financial markets.
Despite the banking sector issues, central banks continued to raise rates. However, a slowing of the pace of those rate rises to 0.25% by the
US Federal Reserve, and a notable softening of rhetoric from the European Central Bank, helped equity markets and corporate credit rally
into the end of the quarter.
Performance Review
The models delivered returns from 1.5% to 1.9% over the quarter.
Global equity markets were broadly positive in Q1, boosted by receding recession worries in Developed Markets and declining energy prices.
Gains came despite turbulence in the banking sector, which caused significant volatility in bank shares, whilst sticky core inflation forced
investors to reassess their interest rate expectations, tempering returns somewhat. Within Fixed Interest, government bonds rose, whilst
Absolute Return was broadly positive over the quarter.
Portfolio Changes
Tactical Asset Allocation
• Increased Fixed Interest, reduced Absolute Return, and equities.
Outlook
Whilst many markets continue to trade at valuation levels below their peaks, the sudden collapse of Silicon Valley Bank in the US was a
sharp reminder of the risks investors face as central banks continue to raise rates to contain inflationary pressures. Although the US Federal
Reserve has moderated the pace of increases, the pressure to continue raising rates remains whilst inflation is above target and the labour
market remains strong. The problem for central bankers and investors alike, with both trying to judge when rates have risen sufficiently to
dampen demand, is that monetary policy acts with a significant and indeterminable lag. To compound the uncertainty further, US consumers
continue to enjoy higher levels of savings than normal, accumulated during the Covid pandemic from government support schemes.
Whilst the UK and Europe are also experiencing a rising rate environment, the outlook for a severe downturn has improved significantly after
a sharp fall in the price of natural gas. However, inflation remains elevated and risks remain, not least from the continuing war in Ukraine.
The picture in China is very different. Whilst the relaxation of Covid restrictions has started a recovery, partly driven by the additional savings
built up by households during the lockdown years, inflation is not yet an issue, and interest rates have actually fallen. This represents a
positive environment for China and the region as a whole. However, with the current level of monetary stimulus being provided to boost the
Chinese economy being well below that which we have seen in recent years, it should not be assumed that the growth generated will be
enough to rescue the global economy should the West tip into recession.
Taking all of the above into account, we have become more cautious on the prospects for equities, reducing exposure to a neutral weighting
but favouring China and the wider Asian region where the macroeconomic situation is more favourable. By contrast, we have added to our
Fixed Interest holdings, as yields have risen to levels that offer an attractive risk/reward profile as well as defensive characteristics.