Financial Update from Brewin Dolphin - 31 March 2023

April 2023

The Weekly Round-up

Friday 31 March 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, highlights the top-performing sectors of the first quarter, and discusses signs of improving economic growth.

As we draw to the end of the first quarter, it has been a reasonable one for equities. The best performers have been technology stocks. The worst performers have been financial stocks. The main drivers of performance have been interest rates, commodity prices, growth expectations and systemic risks.

Technology stocks will naturally do well when interest rate expectations come down. Their perceived long runway of growth becomes more valuable to investors in a low interest rate environment. Additionally, though, as the major losers from last year, technology stocks had been shunned by investors, even sold short by many hedge funds. So a modest improvement in the earnings outlook, and lower discount rate, meant sharply higher share prices as investors scrambled to cover short positions or get back to neutral weights.

Consumer discretionary stocks also performed well. This partly reflects some big technology-enabled companies lurking within the consumer discretionary sector, but the first quarter has also seen an improved outlook for the economy. Whilst at times it seemed inevitable that the combination of high inflation and sharply rising interest rates would lead to a recession, falling energy costs and rising wages have, in fact, left consumers in a robust position.

Growth – still improving

Last week we discussed how the provisional purchasing managers’ indices (PMIs) showed a strengthening services sector. This week’s PMI from China’s National Bureau of Statistics showed growth in both sectors of the economy, despite most other regions seeing their manufacturing sectors contracting. Even in China, the services sector is seeing the greatest pace of expansion. For reference, this was the highest services reading since 2011. It is not that surprising that China is seeing some velocity as it emerges from its crippling Covid-zero policy. China hosted a conference to encourage investment into the region, which was attended by 70 foreign executives including Tim Cook and Ray Dalio. This forms part of Xi Jinping’s ‘Invest in China’ year-long campaign, which aims to keep up the momentum of China’s emergent slingshot out of shutdown.

In the UK, more business surveys reinforced the view of a commercial sector that is expanding and feeling more confident about the future. This morning, the Lloyds Business Barometer reached its highest since May 2022 with a reading that would be consistent with an economy expanding at 2% per annum. It indicated that firms were still planning on increasing headcount, despite fears of a recession.

The Confederation of British Industry’s distributive trends survey suggested that online sales continue to decline as retail trends normalise following the dramatic distortions of Covid and lockdowns. However, overall sales volumes had risen marginally over the last year, which is impressive given the extent of inflation that consumers suffered over that period.

Inflation – still too high

The BRC-Nielsen shop price index provided one of the first indications of how strong inflation was in March. Companies reported prices increasing at a bit less than 1% over the month, with the strongest growth in food prices. Worryingly, this survey suggests the rate of inflation continues to rise at an accelerating annual pace.

But much of this data is just survey data. It is regarded as ‘soft’ data, which reflects the inadequate sample sizes and lack of rigour that might otherwise come from data prepared by the national statistical authorities.

As a result, focusing on official inflationary data can be helpful at the moment. Unfortunately, it takes weeks to prepare this for the UK and US, but European economies are happy to have an early stab in the dark, and they tend to be pretty accurate. This week saw official estimates of the consumer price index (CPI) from Spain, Germany, France and Italy, as well as a eurozone-wide measure.

The results were mixed, with France and Germany both seeing stronger-than-expected inflation, but Italy and Spain suffering weaker increases. The eurozone aggregate measure declined, although this was entirely explained by a sharp reversal of energy price inflation. So far this year, gas prices have fallen more than 50% while oil is down by a still significant 10%. Excluding these factors, inflation accelerated a little. March 2022 was the first month to incorporate the rise in energy prices from Russia’s invasion of Ukraine, so this latest set of data is the first annual data not to be distorted by the invasion. Core inflation, excluding these volatile prices, rose 1.2% during March.

Inflation data for the US continues to reference February. The CPI results a fortnight ago were stronger than had been expected, but there are some indications of an easing coming from the personal consumption expenditures price index. These data, which the Federal Reserve explicitly targets, seem a little more sedate than the higher profile CPI. However, the so-called ‘supercore’ measure – services prices excluding housing and energy – accelerated slightly.

Interest rates – nearly peaked?

Still related to growth and inflation is the outlook for interest rates. The market still expects rates to rise and then fall in the UK and Europe. However, in the US the implied chance of one last rate hike is only around 50%. The collective intelligence of investors is that rates have virtually peaked.

Whether this is true or not depends in part upon the effect of the recent banking crisis on bank lending to the economy. While it is reasonable to believe that the failure of a handful of banks will drive risk aversion among lenders, they were already pretty cautiously positioned, and many consumers still have lots of spare cash. At the same time, falling bond yields in response to the crisis make credit cheaper, particularly in the US where mortgage rates have fallen from around 6.75% to 6.25%. Mortgage approvals have started to rise as a result and a gauge of home sales pending completion was stronger than expected this month, reinforcing the message that US housing market activity is increasing again.

The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.