A Look Back At Markets in August 2023

• Twin peaks – US and UK near top of interest rate cycle

• Denmark gains with weight loss drug

• Not all emerging markets are emerging

August was a challenging month as central bankers were keen to remind markets that although inflation has declined, it is still some way from the universally accepted 2% target. The Balanced portfolio benchmark was largely flat with a return of -0.91%.

Readers of last month’s review may have a sense of déjà vu as Oil markets are still at the forefront of activity, with both Brent Crude and WTI contracts trading at around $90 per barrel, compared to the $83 per barrel level seen last month. Demand is steadily increasing thanks to economic resilience whilst the market sees continuing production cuts by OPEC+.

The widespread use of Oil throughout the supply chain, means that any movement in price is impactful to the global economy. The importance of the continuing strength in the oil market cannot be understated as the Oil price is a significant component of inflation and can ‘move the needle’ either way.

Inflation and Interest rates.

Bank of England governor, Andrew Bailey, said that the central bank is “much nearer” to ending its run of interest rates increases but that borrowing costs might still have further to rise because of stubborn inflation pressures. “I think we are much nearer now to the top of the cycle. And I’m not therefore saying we’re at the top of the cycle because we’ve got a meeting to come,” Bailey told lawmakers. “But I think we are much nearer to it on interest rates on the basis of current evidence.”

Importantly, Bailey acknowledged that UK inflation was set to fall further but questioned how much that would reduce wage growth, which recently hit a record high. Accordingly, the wage-price spiral is a concern for central bankers working hard to reduce inflation, as the growth of wages fuels growth in spending, which subsequently fuels inflation.

In the US, the continued strength of the economy may necessitate further interest rate increases. Speaking at the Jackson Hole Symposium in August, Federal Reserve Chair Jerome Powell said, “We are attentive to signs that the economy may not be cooling as expected and are prepared to raise rates further if appropriate and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” Powell continued by saying that “although inflation has moved down from its peak — a welcome development — it remains too high.”

European Central Bank (ECB) president Christine Lagarde, who spoke recently at a London seminar, offered little insight into the widely followed ECB interest rate decision, due on 14th September. “Actions speak louder than words,” Lagarde said. “We have increased our policy rates by a cumulative total of 425 basis points in the space of 12 months — a record pace in record time. And we will achieve a timely return of inflation to our 2% medium-term target.”

However in a recent report, the OECD (Organisation for Economic Co-operation and Development) said the European Central Bank (ECB) needs to raise interest rates “for as long as possible to put inflation back on a sustainable path towards its 2% target.” The latest data in August showed that inflation across the 20 eurozone countries was 5.3%, with projections expecting it to decrease to 3.2% in 2024.

Economic indicators.

In the US, business confidence improved as the ISM Manufacturing PMI (Purchase Managers’ Index) climbed to 47.6 in August 2023 from the previous month’s 46.4, slightly exceeding the market forecast of 47.0. Although manufacturing activity showed signs of improvement, this reading indicated that activity had contracted for the tenth consecutive month. While production levels stabilised, the inflow of new orders experienced a more rapid decline, and the pace of job shedding showed signs of easing.

The Services PMI unexpectedly jumped to 54.5 in August 2023 (52.5 forecast), pointing to the strongest growth in the sector in six months.
In the UK, the Manufacturing PMI fell to 43.0 in August 2023. This reading remained below July’s 45.3 and represented the lowest point since May 2020, indicating a significant deterioration in operating conditions.

The rate of output decline accelerated to its steepest in a year and ranked among the fastest in the survey’s history. Additionally, the contraction rates for both total new orders and new export business were among the steepest observed outside of the 2007-08 global financial crisis and the COVID-19 pandemic.

Service business activity fell for the first time since January as the UK Services PMI declined to 49.5 (51.5 prior). Despite the lower reading, the service sector beat market forecasts of 48.7 as it suffered only marginal declines in output and new work.

The Eurozone Manufacturing PMI came in at 43.5 in August 2023, up from July’s 38-month low of 42.7 and the highest in 3 months. According to August data, the volume of new orders received by manufacturers across the eurozone continued to plummet at a rate which has rarely been exceeded across the survey’s 26-year history.

Whilst Germany, France, Italy, and Spain, the four largest economies, all remained in contraction territory, Germany (the largest economy in the EU by some distance) posted the lowest PMI of 39.

The Services PMI for August was 47.9, pointing to the first decline in services activity so far this year, and the sharpest since February 2021. The four largest eurozone economies all posted declines, led by France and Germany.

Market performance.

Only 2 out of 23 nations gained this month, with Denmark the notable leader, driven largely by the game-changing weight loss drug developed by Novo Nordisk:

The Danish pharmaceutical giant has gained 22% since the start of August as the much-heralded weight loss drug Wegovy, also known as Ozempic, has been proven to aid weight loss. Consequently, the NHS made a limited supply available to patients as part of weight management services amid global supply shortages due to a surge in demand. This has caused unexpected consequences as the drug is relied upon by diabetic patients to manage insulin levels.

The USA index returned -0.23% whilst the UK market fell, returning -2.53%.

Meanwhile only 4 out of 24 Emerging Markets nations made gains this month. Turkey and Columbia gained 12.62% and 9.29% respectively as both nations continue grapple with double-digit inflation.

Sector performance.

A challenging month for markets was reflected at sector level with only 5 out of 45 sectors producing a positive return, and 2 of those being money markets. Asian powerhouses occupied opposing ends of the spectrum, with India/ Indian Subcontinent gaining 0.75% whilst China/Greater China returned -7.32%.

Summary.

Despite interest rate rises in the US, the underlying economy appears to be strong, largely supported by a resilient service sector despite challenges faced by manufacturers.

According to leading economic indicators, Germany continues to be challenged, particularly by a sharp decline in the demand for manufacturing. It is the alarmingly low readings present within leading indicators that give cause for supporters of ‘dovish’ policy to implore the ECB to stop and reverse their course of action within the monetary policy arena. A tell-tale sign of near-term ECB monetary policy will be delivered in a few days as the Eurozone bank publishes its latest decision on interest rates.

However, investors in Balanced portfolios can take comfort in the fact that even policymakers are starting to hint at ‘peak interest rates’ even if their actions temporarily contradict their words. Once ‘peak rates’ are truly priced in and central bankers choose to ‘cut’, Fixed Income markets are likely to rally back to levels seen in recent years.

Timing this move is exceedingly difficult, but patience definitely pays.

Sources:
BoE governor Bailey: Rates will likely stay higher for longer, Elliot Gulliver-Needham, Investment Week 29/06/2023
‘We would not stand idly by’: Lagarde pledges ECB action if both profits and wages rise, by Silvia Amaro, CNBC 07/07/23
‘24% of owners reported that inflation was the single most important problem in operating their business, down 1 point from last month.’ https://www.nfib.com/surveys/small-business-economic-trends/
Rising corporate margins accounted for 45% of inflation in Europe since the start of 2022, a report released by the International Monetary Fund (IMF) has said.  https://www.imf.org/en/Blogs/Articles/2023/06/26/europes-inflation-outlook-depends-on-how-corporate-profits-absorb-wage-gains
Economic indicators information from tradingeconomics.com
Market and Sector performance data sourced from FE FundInfo, 11/07/23

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