Q1 2023 in review
Global growth has generally surprised positively during the first quarter of 2023. Kick starting markets which are perhaps best illustrated by the rebound in the US and European composite purchasing managers’ index (PMI) business surveys since the start of the year. Lower energy and oil prices have probably played an important role in the improvement in business sentiment, along with the reopening of Greater China. Against this backdrop, developed market stocks returned nearly 8% over the quarter.
The geopolitical backdrop remains challenging, with no end in sight to the war in Ukraine and renewed tensions between the US and China. On the inflation front, headline inflation continued to ease over the quarter on the back of low energy prices, but core inflation generally remained stickier, forcing global central banks to tighten monetary policy further.
The collapse of Silicon Valley Bank (SVB) in March (the second largest banking failure in US history) led to a major sell-off in the US and European financial sectors.
In Europe, despite rapidly rising interest rates and the turmoil in the banking sector in March, economic activity also surprised on the upside throughout the quarter on the back of falling energy prices and the resilience of services activity. This strong momentum was almost entirely driven by the service sector, while the manufacturing sector continued to struggle as shown by the drop in the manufacturing PMI to 47.1 in March.
China’s surprise abandonment of its zero covid policy at the end of last year has led to a strong rebound in its economy since the beginning of the year, while inflation has so far remained surprisingly low, allowing the People’s Bank of China (PBOC) to maintain an easy monetary policy. The non-manufacturing business surveys are showing a strong rebound in the domestic service sectors.
The better-than-expected credit growth in January and February undoubtedly contributed to this better economic momentum. Despite this strong economic momentum and credit growth, China’s February CPI print came in below expectations, rising only 1% year on year, while the producer price index stayed in deflation territory, falling 1.4%. Against this backdrop, the PBOC announced a 25bps cut to its reserve requirement ratio for banks in March, which was earlier than expected.
Hong Kong re-opened its borders with the Mainland the first time since 2020. That is with no restrictions on southbound visitors coming into the city from the Mainland. That will greatly aid the recovering economy, which heavily relies on tourism, although it will take time for a return to the norm.
Asset classes & strategy implications
Markets started the year with a strong January rally for equities. Fixed income markets also reacted positively to the decline in inflation and the prospect of easier monetary policy. In February, equity and fixed income markets were weighed down by strong economic data, which together with sticky core inflation forced investors to reassess their interest rate expectations and price in higher-for-longer interest rates. In March, the collapse of SVB and broader concerns around the financial sector hit bank shares hard, while government bonds rallied.
The fear of a much discussed contagion risk among financial institutions, following both the US and Swiss banking developments, seems to have somewhat faded as events unfolded. The situation has certainly eased, although global banking stocks and CoCo markets have witnessed some volatility and corrections, which opened selective purely tactical investment opportunities within banking stocks. We do still remain wary in allocating to the sector, although believe the recent events created some tactical equity opportunities which could ultimately be switched into the strategic allocation over time. CoCo securities, or AT1 bonds we do not have any direct exposures, nor we intend to implement within our strategies.
Besides the above mentioned tactical allocation to banking stocks, which in relative terms translates into an increase in the equity quote ranging from +1% to +3% no other adjustments have been executed over the quarter, thereby retaining a relative constant allocation. Within the Fixed income allocation, certain rebalances have taken place without deviating from our selective criteria. Besides certain supranational bond exposure, we do not presently hold any banking, or financial institutions credit securities.
Exposure to Asian convertible bonds, which we have been holding over the years through selective funds, has been revised and presently reduced. This is due recent fund liquidations in the asset class, and to a limited number of investment funds meeting our criteria and due diligence checks for re-allocation. Direct investments remain limited, particular in Japan, predominantly due to larger than straight bond ticket sizes, liquidity constraints and current tradable securities.
On the alternative investment side, our exposure to commercial real estate as well as trade finance, have both remained inert and rather resilient, hedging the volatility of other asset classes. Precious metals, namely gold, as at time of writing this piece, quietly reached the $2,000 on the back of a weakening dollar. Crypto assets such as Bitcoin have also gone through the motions, now gaining traction back at the USD 30k levels.
Outlook
As we enter the second quarter, we could expect China’s economy to continue to be supported by its Covid reopening, while developed economies may be facing further downside risks ahead.
The recent events in the banking sector are likely to lead to a further tightening of bank lending standards, which could further slow growth in developed economies, However, with little evidence of extreme excess in the real economy and with better capitalised banks, we would see a repeat of 2008 as unlikely in the short term.
At this stage, there are considerable uncertainties – in both directions - over the extent to which the recent turmoil will affect sentiment and activity. This uncertain backdrop argues against extreme positioning between or within asset classes, thus continue emphasizing of well diversified investment strategies.