From Steven Lloyd, Investment Director, Ascot Lloyd
I’ve been asked why my monthly commentaries have latterly seemed to dwell rather deeply on the state of the US economy, and less on the UK, which after all is our investors’ home and more familiar territory.
Essentially, despite holding less than 4% of the world’s population, the US controls the financial architecture that drives the global economy. The US dollar is the world’s main unit of account, i.e., its measure of the value of goods and services. It amounts to 60% of global currency reserves, around 40% of global payments, and a quarter of global GDP.
The two main US exchanges, the NYSE and Nasdaq, together constitute over 40% of global stock markets by value. Of the world’s 100 largest companies, more than two thirds are US businesses. The UK meanwhile has four in that list, and the London Stock Exchange in total represents less than 4% of global stock markets by value. In a nutshell, as this rather hackneyed expression conveys, “Wall Street sneezes, and the world catches a cold”.
Irrespective of how directly exposed to US equities your portfolio is, nevertheless, the monetary strategy adopted by the US central bank, the Federal Reserve, and the way it manages interest rate policy, has a significant impact on most economies, their stock markets, and ultimately the value of your portfolio.
As I reported last month, the start of 2023 was positive, with the narrative involving so-called ‘hard’ or ‘soft’ landings for the US economy as investors convinced themselves that some version of a recession might be imminent, along with ‘peak’ inflation and by extension falling interest rates. Any prospect of lower rates drives down bond yields (via higher prices) and increases share prices (as companies’ and individuals’ borrowing costs fall). It also reduces the relative value of the currency. A further fall in the dollar reduces the cost of goods priced in it (eg oil and most industrial metals) and increases the spending power of any economy borrowing in dollars (because repayments in one’s own currency will be less). As a consequence, the outlook for China and Emerging Markets’ stock markets improved dramatically at the turn of the year.
However, a month is a long time in economics. Perhaps counter-intuitively, in February strong data on US job growth and retail sales were received as negative news. Along with higher-than-expected inflation numbers, the new shorthand for expectations now includes “no landing” (no recession), and hence “higher for longer” (inflation, and thus interest rates). US shares fell by over 2% while Asia and Emerging Markets were harder hit, falling by over 6%. Bonds declined too as yields rose to match revised interest rate expectations.
Despite similar interest rate hikes, the experience in the UK and Europe was somewhat more positive than elsewhere. Gas prices have fallen by 40% already this year, thanks to high storage levels given the unusually mild winter. This confidence booster has improved the chances of a less-punitive recession, and UK and European markets continued their upward trend, now gaining 6 and 8% respectively since the new year. The Bank of England Chair Andrew Bailey suggested we had “turned the corner” on inflation, with both the core and headline rates reducing to 10.1%. Mr Bailey spent rather less time explaining the rise in food prices to an eye-watering 17%, not all of which can be blamed on a tomato shortage. Nevertheless, the index of our largest 100 companies consequently reached a record, crossing the 8000 mark in mid-February. Market indices at levels with neat round numbers are often described as “psychologically important” by traders who are not psychologists. Reflecting the extent of its psychological importance, the index retreated below that level almost immediately.
Inflation made the headlines in more ways than the obvious in February. The excitement surrounding China’s post pandemic reopening, and consequential high hopes for Asian and Emerging Markets, faded somewhat during the month as geopolitical tensions brought about by “Balloongate” put a brake on China’s stock market recovery. Presidential orders deployed one of the world’s most advanced fighter planes to join in air-to-air combat with various suspicious inflatables, thus resulting in a hard landing for a balloon if not an economy. Surveillance by balloon (despite myriads of our and their satellites doing the same thing) seems to have come as a shock, it merely reminds me that “everybody spies”.
When calm and sense returns, we expect Asian economies to continue their growth, but to what extent remains up in the air.