7 Minutes on Markets - Q2 2023 Market Update

Host:
Welcome to a new episode of 7 Minutes on Markets. Today I have been joined by Salim Jaffar, Investment Analyst.

Salim Jaffar:
Hi everyone.

Host:
And Ben Kumar, Head of Equity Strategy.

Ben Kumar:
Hello.

Host:
Welcome both. So to kick off this conversation, what themes have we seen in markets so far this year?

Salim:
Pretty much the opposite of what happened in 2022. Over 2022, the Nasdaq had its worst year since the GFC and was down a staggering 33%, led by huge losses in the mega cap names we all know. Meta was down 65% and Google or Alphabet down 40%. The FTSE 100 fared relatively better, and this was because it was propped up by the only major sector that ended the year in the green: energy.

Fast forward to the first quarter of this year and the world's been pretty much turned on its head. The Nasdaq is up 21% over the quarter, driven by the exact same stocks that really hurt it in 2022, and the FTSE has only delivered 1.5% as sectors such as energy, which drove its 2022 performance, have lagged.

Host:
Thank you, Salim. And still sticking with you, what are markets so excited about?

Salim:
So as always, there are a number of things that we can point to. So, the US economy still drives the global economy. And inflation data, which everyone's been really scared about, has been getting better as the March core inflation figure came in at 5.5% - somewhat of a return to normality. This caused markets to get pretty excited because it increases the probability that those pretty painful rate hikes might come to an end.

Ben:
You've also got another factor which is: look, compared to the first quarter of 2022, this quarter has been a lot better. You haven't seen an invasion in continental Europe and you've seen energy prices fall back - partly because of that lack of invasion, or lack of it getting worse, energy prices have fallen back to far more reasonable levels. Add into that a warmer winter than expected and you've got natural gas prices nearly 90% lower than they were at the worst part of the Russia-Ukraine invasion.

Salim:
So the last factor I would point to is China. So after three pretty strict years of lockdowns, it looks like the reopening is here to stay and markets are getting pretty excited about this. It could result in a pretty considerable boost to domestic demand, global commodity demand and global demands through a number of other factors such as travel.

Host:
Sounds very optimistic. Do you think this optimism is going to last? Yes or no? Why or why not?

Salim:
No, unfortunately not. The pain that the global economy will feel from rate hikes just isn't over. Most central banks will tell you themselves that economies don't feel the full impact of rate hikes until about 18 to 24 months after they've happened. Now the first rate hikes happened in the US just over a year ago, and they're pretty much still rising. The reason for this is that interest rates have a really, really complex relationship with the economy. It's not just money getting more expensive causing people to use less of it.

In reality, there are a huge number of channels through which the economy is impacted by rates, and some of these take a pretty long while to feed through to actual prices. So, unfortunately, pain is most likely due in the interim.

Ben:
The kind of pain Salim's talking about, it's actually more like a series of dominoes tipping over gradually as interest rates feed through into, you know, what really makes the economy go round. So as interest rates rise, it starts to become less and less appealing for people to move house. As people move house less or buy houses less, that starts to impact the profits of companies that benefit from a booming housing market. That's everything from the estate agent that's selling the house, the lawyers who do the conveyancing, all the way through to the people that sell you a sofa or a can of paint to do up your new home.

Once those companies start suffering, you know, once they start seeing their profits fall, they start making the only decision a company makes when it's in trouble, which is reducing the size of their workforce. Now, once that happens, inflation starts to come down. But we're only right at the start of the very first of those dominoes beginning to topple.

Host:
Thank you very much, Ben and Salim. And looking ahead, what are the main things we need to look out for?

Ben:
You know, I think the housing market is a really, really important one. If you look at the US at the moment, you know, someone who has a house worth $500,000 would be paying maybe around $1200 a month in their mortgage payments. But because rates have gone up so much, if they wanted to get that same mortgage now, or even a slightly bigger one to upgrade to a $600,000 house, they'd be paying more than double that 1200 a month. That incentive to move is just so much less when it's going to cost you more, you know - higher mortgage costs than feed into higher rents and so on and so on.

The other thing other than housing to watch for, though, is, look at the temporary workers in the US because the people that are laid off first by companies are the ones who are on zero-hours contracts or only come in a couple of days a week. They're the ones who are told first not to come into work and you're just starting to see that tick up as those part-time bar staff or waiters and waitresses are told stay at home. The demand isn't there.

Host:
Thank you very much. And in this type of backdrop, how do you prepare your portfolios?

Salim:
Great question because it's all very well having the correct worldview, but it's actually your portfolio implementation which is going to deliver your attempts. So we've got a number of positions that we think are going to perform well in this recessionary environment.

Ben:
First thing to do is just avoid areas of pain. You can do that in a couple of ways. Number one: just don't own them in the first place, take your exposure to equity markets right down while still keeping clients invested for the long term. And then with that equity exposure that you do have in portfolios, take it in places that are more robust and resilient. It's companies like healthcare companies that tend to ride out recessions pretty stably. It's companies actually like energy companies, the big energy majors, have successful reliable business models and have a lot of cash. And you can still take some opportune risks where the time is right, but you do so carefully and while thinking about the rest of the portfolio at the same time.

Salim:
Another one's bonds. So we've talked about rates a bit and rates are that much higher that the base level of return you get is far more attractive than it has been. But also very importantly is bonds increasingly offer genuine diversification. We've had rates bobbing around zero for such a long time that in the events of equity market sell-offs, rates can't really go down and that's where you get price appreciation from bonds. Now we've got that. So we've gone overweight bonds.

Ben:
The final one we talk about a lot is alternatives positioning. You know, we have a basket of alternatives that are reliable returners with a little bit of a defensive air to them as well. When things get difficult, our alternatives tend to do a little bit better.

But the final thing to do when you're confronted with a difficult recessionary environment as a portfolio manager is to tolerate the volatility. It's really important not to let your emotions run away, not to get scared, not to get panicked, and when everyone else is panicking, to start looking for the opportunities that you can invest in for the long term.

Host:
It was great to hear your insights, Ben and Salim. Thank you very much. That is all from us at 7IM - thank you for listening.