- Shunil Roy-Chaudhuri
- 28 April 2023
- 15 mins reading time
On 26 April we hosted a webinar for clients of Schroders Personal Wealth (SPW). This briefing is based on that webinar.
The markets have been through a turbulent period, with the banking sector in the eye of the storm. In particular, US tech lender Silicon Valley Bank (SVB) fell victim to today’s higher interest rate regime. It was followed by Credit Suisse, which was taken over by Swiss rival UBS. SVB and Credit Suisse both faced falling deposits. In effect, these were old-fashioned bank runs.
We believe strains on US regional banks are likely to continue. This evokes memories of 2008 and leaves many people understandably worried about their investments.
In 2008 people queued up outside Northern Rock to make withdrawals. But, with SVB, we saw only technology companies trying to take money out of a bank that held deposits solely for the technology sector. And, crucially, banks today have greater financial reserves than they did 15 years ago, which gives us confidence that we won’t have a rerun of 2008.
Even so, in the US, changes to banking regulations only focused on larger national US banks, not to the second-tier banks such as SVB. But we now expect to see regulations in the US tightened further, which may provide some reassurance to concerned investors.
Banking wobble was short lived
It’s worth stressing that, in the year to 6 March, just before the SVB collapse, market performances in 2023 had been generally good, with rises in all the major asset classes apart from commodities. European equities (shares), on which we had a positive stance, were doing particularly well.
But equity markets took fright at events in the banking sector and equities fell indiscriminately between 6 and 23 March. Even so, by 24 April they had broadly recovered, with the year-to-date returns of US and European equities greater than they were on 23 March.
So the markets have been on a rollercoaster in 2023, showing how unexpected events can have a big short-term impact. But SPW portfolios are built for the medium to long term, in an effort to ride out such short-term fluctuations.
Turning now to broader economic issues, a key current theme is inflation, which has hit 40-year highs in recent months, driven by the Ukraine war and supply chain issues. There have been price rises in oil and food due to the fact that Russia is a key oil producer and Ukraine a key wheat producer. As a consequence, there has been a cost of living squeeze for many of us.
Could inflation come down?
Moreover, bottlenecks in the supply of goods after the pandemic have also driven up inflation. But we believe we are getting close to the peak in inflation and could even be seeing it come down. For example, US inflation (CPI) peaked at 8.9 percent in June 2022 but fell to 5 percent in March 2023 (1).
Even so, current high employment levels in the US and UK mean companies need to offer higher wages to retain staff, particularly as there are significantly more job vacancies than unemployed people in the US. And these high wages have an inflationary impact.
There have also been large rises in interest rates in the last 12 months. Central banks use interest rates to bring down inflation. Rate rises increase the cost of borrowing on mortgages, credit cards and loans, which can lower inflation as consumers have less to spend on goods and services.
But there’s a challenge: if central banks raise interest rates too much, then they could trigger a recession. There have been many recent interest rate rises in the US, but fewer in Europe. However the good news on interest rates is that the rate of increase is slowing down and, in our view, they are approaching a peak. We think the US will go into recession, albeit a short and shallow one, but we also think this will allow the US central bank, the Federal Reserve (Fed), to then cut interest rates. We expect the US to be out of recession in 2024 as interest rates are cut.
Moreover, while Schroder Investment Management (SIM) does expect global economic growth to decline from 2.9 percent in 2022, it has raised the 2023 forecast to 1.9 percent. SIM also expects global economic growth to rise to 2.2 percent in 2024.
Positive outlook for China
In our view, the short-term outlook for China is more positive than for the US. Last year China had zero-Covid policies and lockdowns. But these policies have generally been removed, which should benefit emerging markets and the global economy in 2024.
In particular, we believe there is pent-up demand in China as a result of lockdowns. We think people in China will start to spend more domestically now lockdown restrictions have been removed. We also think that they will then travel abroad, driving global economic growth, in line with the infographic from SIM below.
Source: Schroder Investment Management, March 2023
In Europe, inflation has been falling and interest rates haven’t risen as quickly as they have in the US. Europe was affected by higher oil prices, but it held substantial quantities of gas in storage and had a mild winter. This helped drive energy prices down significantly.
The UK economy has been more resilient than expected and has avoided a technical recession. But UK inflation is still high, at 10.1 percent in March, due to elevated food prices. The Bank of England (BoE) has raised interest rates to 4.25 percent (2), in an effort to control inflation. But high inflation combined with higher interest rates have led to cost of living challenges for many of us.
Even so, we believe the UK is close to the peak level of interest rates. We think interest rates may come down towards the end of 2023 and into 2024.
But we do note that only 26 percent of housing stock in England is owned on a mortgaged basis and that a large proportion of people with mortgages are on fixed rate deals (3). This suggests that rising interest rates may have a smaller impact on inflation than they did in earlier periods.
High income from bonds and low equity valuations
Looking ahead, we do see grounds for investment optimism, despite global economic challenges. This is because we believe the two main investment asset classes, fixed income and equities, look attractively priced in the medium to long term.
As the chart below shows, the income available from fixed income has risen significantly since the start of 2022. High quality (investment grade) bonds now offer income of around 5 percent, making them attractive investments in their own right and for the purposes of investment diversification.
Source: FactSet April 2023. Past performance is not a reliable indicator of future results.
Turning now to equities, the chart below shows how price-to-earnings (PE) ratios have fallen since the start of 2022. In broad terms, a company with a PE ratio of 10x has a valuation of 10 times its current expected earnings. The chart shows average company valuations for various regions and we believe it suggests that equity valuations have improved since the start of 2022.
Source: Bloomberg, Refinitiv, Data Stream, Robert Schiller, FactSet, April 2023. Shiller CAPE is the cyclically adjusted price to earnings ratio base on a markets forward earnings. Past performance is no guide to future returns.
Last year was an exceptionally bad period for every main asset class apart from commodities. But we believe it is vital not to panic. In our view, it is important to consider the basic drivers of economies and markets.
In particular, as interest rates start to peak, and we believe we are approaching the peak, then fixed income assets could potentially perform well. This is because bond prices often rise when interest rates decline.
So we now have a positive view on fixed income and lower risk assets. In particular, SPW’s low risk portfolios have relatively high allocation to fixed income investments with longer expiry dates, as these could potentially have a high sensitivity to interest rate falls. So SIM and SPW are actively managing portfolios in difficult times.
(1) Federal Reserve Bank of St Louis, ‘FRED graph’, CPI for All Urban Consumers: All Items in US, 28 April 2023.
(2) Bank of England, ‘Interest rates and Bank Rate’, 28 April 2023.
(3) Refinitiv, ONS, Bank of England, Schroders Economics Group, 10 March 2023.
Schroder Investment Management (SIM) provides investment management and advice services for Schroders Personal Wealth (SPW) funds and portfolios respectively.
Any views expressed are our in-house views as at the time of publishing.
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The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors might not get back their initial investment.
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