June was a reminder of the complex relationship between economic indicators and market performance, leaving investors with a challenging landscape to navigate. Global economies experienced a mixed bag of surprises in June, with the UK's modest economic growth overshadowed by inflation-induced rate hikes. Meanwhile, Europe and the US grappled with lower-than-expected inflation rates. In contrast, Turkey's central bank took drastic measures to combat economic challenges, and China faced hurdles with shrinking exports and factory activity. Amidst this backdrop, equities managed to shine bright, leaving us intrigued about the future trajectory of these trends and whether equities can sustain their first-half momentum through to the end of the year.
The UK economy experienced modest growth of 0.2% in June, primarily driven by expansion in the service sector.(1) However, sticky inflation remained a concern, surpassing expectations and remaining steadfast at 8.7%.(2) In response, the Bank of England (BoE) raised rates for the 13th time since 2021 to 5%. This pushed up borrowing costs and caused the average two-year fixed mortgage rate to rise above 6.5% based on 75% loan to value (LTV), piling on the pressure of cash-strapped homeowners facing remortgaging.(3)&(4) Despite these challenges, the Cboe UK All Companies index managed to rise by 1.11% in June.
Eurozone inflation in June came in lower than expected at 5.5%, according to preliminary data, but core inflation, excluding energy and food, rose to 5.4%.(5)&(6) The European Central Bank (ECB) raised rates to their highest level in 22 years, signalling their commitment to tackling inflation. Mirroring the UK, the MSCI Europe ex-UK index rose by an impressive 2.42%, suggesting investor confidence in the region is resilient. This is supported by the valuation gap between the index and the S&P 500 on respective forward price-earnings ratios of 12.98 and 19.40.(7)&(8)
The US Senate passed the debt ceiling bill in early June, averting a potential default. Inflation in the US rose at the lowest rate in two years, up 4% over 12 months.(9) The Federal Reserve (Fed) surprised the market by pausing its rate hike campaign after 10 consecutive increases. Fed Chairman Jerome Powell acknowledged that inflation remained high and the process of bringing it back down to 2% would take time. Despite this, the US equity market performed strongly, with the S&P 500 and Nasdaq rising by 3.89% and 3.87% respectively, leading the equity market indices observed in this report.
Japan's Nikkei 225 index experienced a modest rise of 1.26%, as inflation re-accelerated in the region for the second time in three months. The Bank of Japan continues to maintain a negative interest rate.
New Zealand faced a setback as its economy contracted by 0.1% in the first quarter, pushing it into a technical recession.(10) This decline is blamed on adverse weather events caused by the cyclones. In May the central bank raised interest rates to a 14-year high of 5.5%.
In a dramatic U-turn, Turkey's central bank surprised the market by raising rates to 15% in an effort to combat inflation. This move comes as the recently appointed finance minister, Mehmet Simsek, aims to return Turkey to economic orthodoxy. Previously, rates had been lowered from 19% in 2021 to 8.5% in March 2023, despite mounting inflation pressure.(11)
The MSCI Emerging Market index rose 1.19%, with India delivering another solid month of returns up 2.07%. This is in stark contrast to the MSCI China H index which returned -0.6% making it the worst-performing region in those monitored, as it struggled with declining exports and shrinking factory activity. The standout driver of emerging markets in June was Latin America equities, driven by the deteriorating relationship between the US and China. Countries like Mexico are big beneficiaries of the frosty relationship. The MSCI Emerging Market Latin America index returned 12.01%.
China's post-Covid recovery continued to disappoint in June, with exports sinking by 7.5% and factory activity shrinking for the third consecutive month. The country also faced the worst producer price falls in seven years, raising concerns about the risk of deflation. These challenges highlight the need for China to address soft demand and regain momentum in its economic recovery.
June proved to be a fruitful month for equities, as the MSCI World index recorded a 3.38% increase. This surge was primarily attributed to the US Federal Reserve's decision to pause rate hikes and falling inflation, and the alleviation of concerns about a potential debt default in the US. Surprisingly, despite the anticipation of further rate rises, stocks managed to post gains. Notably, the Nasdaq experienced significant growth, marking its best start to a year in the last 40 years. Another notable milestone was Apple becoming the first company to achieve a market cap of over $3 trillion by closing at the valuation on the last trading day of the month.
On a style basis, both Growth and Value stocks performed well in June. Equity returns were fairly evenly split, with the MSCI ACWI Growth index recording a 3.20% increase and the MSCI ACWI Value index up by 3.13%.
Bond investors faced a challenging month, as the Bloomberg Global Aggregate TR index saw negative returns of -1.99%. This decline can be attributed to investors digesting June's rate hikes and anticipating further increases. Federal Reserve Chair, Jerome Powell's comments indicating the possibility of an additional 50 basis points rise before the year ends added to the uncertainty. As a result, US Junk loan defaults reached new highs due to the mounting pressure of interest rate rises.
Despite rising bond yields, the MSCI ACWI/REITS index rose by 1.42% in June. This unexpected increase can be attributed to investors' optimism that the rate-hiking cycle is either peaking or nearing its peak. This positive sentiment in the property market defied expectations and provided a boost to investor confidence in the asset class.
Gold experienced a significant decline in June, with the LBMA Gold Bullion LBMA Sterling/Troy Ounce returning -4.97%. This drop can be attributed to US yields reaching fresh highs. However, in general, commodities performed relatively well, with the Bloomberg Commodity GTR index posting gains of 0.93%, despite concerns about falling inflation and rising interest rates.
Considerations for long-term investors
With New Zealand entering a technical recession and talk that central bank interest policy could tip other economies into recession in the months and quarters ahead we highlight what a recession is, the types of recession there are, how long they can last, as well as what types of investments to consider.
A recession is defined as a significant decline in economic activity, typically marked by two consecutive quarters of contraction in GDP. It is characterised by reduced consumer spending, business investment and overall economic output.
There are different types of recessions, each with its own underlying causes. Cyclical recessions occur as a natural part of the economic cycle, with periods of expansion followed by contraction. Structural recessions, on the other hand, are caused by fundamental changes in the economy, such as technological advancements or shifts in global trade patterns. Financial recessions result from disruptions in the financial system, such as banking crises or asset bubbles bursting.
To prepare for a recession, long-term investors can employ several strategies. Diversification is key, as spreading investments across different asset classes, sectors and geographies helps reduce the impact of a recession on a portfolio. Focusing on high-quality investments is also important, as companies with strong balance sheets, stable cash flows and competitive advantages are more likely to weather the storm and recover faster when the economy improves. Identifying funds that invest in these types of companies takes a little bit of work but should be worth it in the end. Take a closer look at a fund’s holdings to see if it includes well-established companies with a track record of success. Look out for managers that are synonymous with investing in quality companies. Research the fund's investment philosophy and strategy. Additionally, it is crucial for investors to stay focused on their long-term investment strategies and avoid making knee-jerk reactions based on short-term market movements.
The duration of recessions can vary widely, ranging from a few quarters to several years. Factors such as the severity of economic imbalances, the effectiveness of policy responses and global economic conditions all play a role in determining the length of a recession. Defensive funds, which invest in sectors less affected by economic downturns such as consumer staples, healthcare and utilities, tend to perform well during recessions. Bond funds, particularly those investing in high-quality fixed-income securities can also provide stability and income.
It is important to note that past performance is not indicative of future results and investors should carefully consider their investment objectives and risk tolerance when selecting funds. While New Zealand's recession may worry some, it is crucial to remember that recessions are a normal part of the economic cycle and markets tend to recover over the long term.
Sources: FE Analytics (monthly performance figures for funds and market 31/05/2023 to 30/06/2023). Qualitative commentary from TILLIT meetings with fund managers. Index returns are expressed in sterling terms unless otherwise stated.
(1) Source: UK Month on Month GDP
(2) Source: UK Inflation
(3) Source: UK base rate
(4) Source: UK average mortgage rate
(5) Source: Eurozone inflation rate
(6) Source: Eurozone core inflation rate
(7) Source: MSCI Europe ex-UK index forward price-earnings
(8) Source: S&P 500 index forward price-earnings
(9) Source: US inflation rate
(10) Source: New Zealand GDP growth
(11) Source: Turkey bank rate
Date of publication: 7th July 2023
The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.
When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.