SPW MarketWatch: February 2023

UK equities hit a record high

The index of the 100 largest UK companies hit a record high in mid-February, showing that a struggling domestic economy doesn’t necessarily translate into a struggling stock market. Mind you, most of the revenues from these blue chip companies comes from overseas, and so are less affected by the UK’s economic challenges. These global companies also benefited from a weak pound, as their overseas earnings were often made in stronger foreign currencies.

The positive monthly performance of UK equities (shares) contrasted with the negative performance of global equities and North American equities. The UK stock market benefited from its high exposure to energy companies, which have performed strongly at a time of high energy prices. Unfortunately the long-term historic performance of the UK stock market has been dwarfed by that of global equities and US equities. This is largely due to the UK’s limited technology holdings, with tech giants such as Apple and Amazon having driven the growth of the US stock market in recent years.

It can be hard to predict the shifting performances of different geographical regions. This is why, at Schroders Personal Wealth (SPW), we believe in the benefits of diversification, of not putting all your investment eggs in one basket. We are global investors, and our multi-asset funds and portfolios have significant holdings outside the UK. For example, our medium-risk SPW Balanced Portfolio Fund currently has 13.5 per cent exposure to UK equities, compared with 21.2 per cent exposure to US equities.

Our overall stance on equities is currently slightly cautious. We think global interest rates may be reaching a peak, which could benefit equities, but we are also alert to global recessionary risks.

Bonds wobble but yields rise

Falling bond prices in February dented investor hopes that these fixed income assets might now be on an upward trend. Government bonds and higher risk (high yield) corporate bonds underwent declines globally. High-quality (investment grade) corporate bonds were particularly badly hit, falling by 2.5 per cent during the month.

These falls contrast markedly with January’s bond price rises. But surprisingly positive US jobs data at the start of February suggested to many investors that higher US rates might be needed to cool the US economy and dampen inflation. US bonds comprise a significant proportion of global bonds, and bond prices often fall when interest rates rise.

These bond price swings follow on from steep price declines in 2022 as a whole. Last year, global government bonds fell by 13.4 per cent, global investment grade corporate bonds fell by 16.6 per cent, and global high yield bonds fell by 15.8 per cent.

But bond yields rise when bond prices fall. And bond yields, which turned ultra-low – and even negative – in the years following the 2008 financial crisis, today look more substantial. At the time of writing, WSJ Markets data showed yields were around 5.5 per cent on investment grade US corporate bonds, around 7.3 per cent on European high yield bonds, and 7.8 per cent on emerging market government bonds. These yields suggest bonds could potentially return to their traditional role as providers of income, particularly if inflation falls.

We retain our positive stance on developed market government bonds. We believe higher interest rates are starting to cool economic growth, which could potentially dampen inflation and limit the need for further rate rises. But we are slightly cautious on corporate bonds, whose prices have risen relative to prices of government bonds.