Richard Warne, Senior Portfolio Manager, Copia Capital

Despite entering the quarter with a degree of optimism, driven by expectations that central banks would get on top of inflation, the third quarter continued to deliver mixed returns as investors navigated several macroeconomic concerns.

Macro concerns shaping market dynamics

So what happened over the last quarter? Inflation continued to concern investors, along with the view that interest rates are likely to remain high over the short to medium term. With continued wage growth, particularly in the US and UK where tight labour markets have contributed to rising wages, and a recent spike in energy prices. As a result, analysts warn that central banks may struggle to bring inflation back to their 2% target. Towards the end of the quarter, market sentiment was influenced by the possibility of a US government shutdown, but fortunately, this was averted by a last-minute deal.

Equity returns were mixed over the period. The UK market emerged as the strongest performer, with gains of 2.6% boosted by exposure to energy companies which benefited by rising oil prices. Japan also performed well, thanks to stronger economic growth prospects. The US posted a modest gain, although returns were somewhat inflated by a significant rally in the US dollar, which gained 4% versus the pound. Looking at the market in local currency terms, the US actually finished the quarter lower. This included the mega-cap technology stocks, like Apple, Microsoft and NVIDIA, which were driving the market’s strong growth earlier in the year. The European and Asian markets, down 1.6% and 1% respectively, fared less well primarily due to the lacklustre economic data coming out of the regions.

After a challenging first half to 2023, energy fuelled significant gains in commodities. Oil prices surged nearly 30%, largely due to supply cuts from Saudi Arabia and Russia while global demand remained strong. Returns from other commodities were negatively impacted by the strong dollar.

Looking forward, we are seeing some interesting trends in fixed income, the UK market and infrastructure.

Focusing on fixed income

Fixed income has been a hot topic for a long period now. Our view is that the outlook for the bond market remains mixed. In the last quarter, elevated inflation expectations along with signals from central banks that higher interest rates are likely to persist, led to yields on 10-year Gilts and US treasuries reaching levels not seen since 2008. At the same time, short-duration investment grade bonds, which are less affected by changes in interest rates, generated gains over the period. We therefore prefer to keep bond exposure in short duration and are focusing on high quality businesses that are close to maturity. The latter offer an attractive level of return and typically exhibit a low level of risk.

Outlook for the UK market

After a strong Q3, the outlook for the UK market remains encouraging. The recent Northern Ireland Brexit deal demonstrates that the UK Government is now taking a much more positive approach with Europe. This should help the UK look more investable to international investors, who have tended to shun the asset class since the Brexit vote back in 2016.

Opportunities within infrastructure

The past 18 months have been challenging for infrastructure as an asset class, as interest rates and inflation have continued to rise. Many investors had moved to real estate investment trusts (REITs) and infrastructure as an alternative for fixed income due to low yields on bonds. However, we are now seeing a reversal of this, with real estate and infrastructure facing declines last quarter due to ongoing uncertainty over interest rates.

Taking a longer-term view though, governments and companies globally are now taking a more serious stance on decarbonisation. If this comes to fruition, the infrastructure spend needed to facilitate change will be huge, creating a significant investment opportunity.

Overall view

Looking ahead, the challenging macroeconomic environment is set to continue, with inflation likely to persist above central bank targets and interest rates at higher levels than we’ve seen for several years. However, we are cautiously optimistic regarding value returning to certain market sectors, with opportunities starting to emerge for long-term investors.

Our unique Risk Barometer, which takes the data from hundreds of market and economic variables, including equity prices, bond yields, and the gold price, to generate an overall investment risk score of between +1.0 and -1.0, is reading -0.62 as of 30th September 2023.

The Risk Barometer uses a red, amber and green system to show the level of risk, with green (risk scores between +1.0 and 0.33) indicating that global economic signals are more positive than negative and red (-0.33 to -1.0) the opposite, while amber (0.32 to -0.32) suggests the outlook is more balanced. The Q3 score is 0.05 up on last quarter, but remains in the red zone, indicating that the global economic outlook is still negative and that our Risk Barometer is getting more negative signals than positive.

Against this backdrop, diversification remains crucial. We continue to favour value over growth and focus on quality dividend-paying businesses with solid earnings, good financial management and the ability to pass on cost increases to customers.
We still believe caution is warranted, but are taking advantage of investment opportunities as they arise.

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