Market Opinion - March 2023

Market Opinion - March 2023

March witnessed a mixed performance in global equity markets, with notable events impacting different regions. The troubles in the banking sector took center stage, particularly with the collapse of Silicon Valley Bank (SVB) and Credit Suisse, which raised concerns about a potential global banking crisis. However, these fears were somewhat alleviated over time.

Europe experienced an equity market sell-off in the first half of the month due to banking sector troubles but managed to end the month positively. The highlight was UBS's takeover of Credit Suisse, facilitated by the Swiss regulator, government, and National Bank. The deal included a guarantee of CHF9 billion and considered the potential write-down of UBS' Additional Tier 1 (AT1) bonds. Despite market volatility, the European Central Bank (ECB) raised interest rates by an additional 0.5% as inflation fell to its lowest level in a year.

In the UK, equity markets ended in decline as the SVB and Credit Suisse saga, along with inflation persisting above expectations, affected investor sentiment. However, positive economic news emerged as the economy grew by 0.3% in January, avoiding a recession. Factors such as children returning to school, football schedules, and a strong month for private healthcare contributed to the growth.

The US experienced a two-part month for equity markets. The first half was impacted by the SVB crisis and persistent inflation, leading to a decline in investor sentiment. However, the second half saw recovery driven by big technology firms and expectations of tempered interest rates. SVB's collapse was triggered by massive withdrawals of $42 billion in deposits, mostly invested in devalued long-dated securities. Inflation remained elevated, casting doubt on the Federal Reserve's decision on interest rates, but it eventually raised rates by 0.25%.

Asian equities advanced, with China, Korea, and Taiwan leading the way. Investor confidence improved after the banking sector troubles had limited impact on Asian financials. Taiwan and Korean markets benefited from signals of a less aggressive stance on inflation by the US Federal Reserve. Chinese equities rose due to further government support for the internet and gaming sectors.

Emerging markets performed well, with Asia leading followed by Latin America and Europe, the Middle East, and Africa (EMEA). While EMEA initially faced challenges due to the banking sector, news of Credit Suisse's merger with UBS helped calm investor nerves. However, Argentina's performance dragged down Latin America, while positive macroeconomic indicators in Mexico and hopes for political stability in Peru had a positive impact.

The bond market experienced turbulence, driven by the SVB collapse and UBS's takeover of Credit Suisse. However, market calm returned toward the end of the month as concerns about aggressive interest rate hikes eased. Government bonds rallied, influencing investment-grade credit. US investment-grade bonds rebounded strongly, and European shares ended higher despite the bank sell-off. Information technology and consumer staples were the best-performing sectors, while real estate and financials detracted.

In summary, March witnessed significant events in the banking sector, impacting equity markets globally. While concerns about a banking crisis emerged, they were somewhat assuaged over time. Different regions faced varying challenges, but overall, market sentiment recovered, aided by factors such as central bank actions, political stability, and positive economic indicators.

UK equity markets closed lower in March due to a sell-off in bank shares, which had a negative impact on overall market performance. Inflation in the UK unexpectedly rose in February to 10.4%, surpassing the consensus forecast of 9.9%. This increase was driven by a record high food price inflation of 18.3%, attributed in part to supply shortages of salads and cucumbers. Core inflation, which excludes volatile food, energy, alcohol, and tobacco prices, also saw an increase from 5.7% to 6.2%. Despite these inflationary pressures, the Bank of England (BoE) anticipated a rapid decline in inflation before the summer.

The BoE raised interest rates by 0.25% to reach a 15-year high of 4.25%. This marked the 11th consecutive rate hike since the bank began its tightening cycle in December 2021. The BoE indicated the possibility of further rate increases if inflationary pressures persist. Additionally, the bank no longer predicted a technical recession and expected economic growth in the second quarter of the year. In March, Jeremy Hunt presented the budget, which included extensions of free childcare and the removal of the lifetime allowance on tax-free pensions to encourage workforce participation. Other measures announced aimed to extend the energy price cap, provide tax breaks for capital expenditure to offset the rise in corporation tax, and enhance London's appeal as a listing destination.

The UK economy grew by 0.3% in January, following a contraction of 0.5% in December, according to the Office for National Statistics (ONS). This growth surpassed consensus forecasts, primarily driven by factors such as children returning to classrooms, a full football schedule, and a strong month for private healthcare. However, the construction sector experienced a significant decline. ONS data revealed a slowdown in UK wage growth in the three months leading up to January. Employers exhibited increased uncertainty about hiring due to the prevailing economic climate, even as the unemployment rate remained near record lows at 3.7%. British retail sales in February increased by 1.2%, demonstrating consumer resilience for the second consecutive month. The consumer confidence index, reflecting personal finance and economic prospects, reached -36 in February, the highest level since March 2022, according to Growth for Knowledge (GfK), a research group.

The US equity market experienced two contrasting periods. Initially, persistent inflation and a banking crisis dampened investor sentiment. However, a recovery occurred in the latter part of the month driven by major technology companies, as expectations for higher interest rates were scaled back. The market turbulence started when Silicon Valley Bank (SVB) faced a liquidity crisis, leading to its closure by US banking regulators. SVB held a significant amount of uninsured deposits, and a bank run resulted in the withdrawal of $42 billion in one day, prompting the intervention of the Federal Deposit Insurance Corporation. SVB's investments in long-dated securities had devalued due to aggressive interest rate hikes by the US Federal Reserve (Fed). The crisis also affected other regional banks like First Republic and Signature Bank, with the latter also closing.

The Fed's interest rate decision in March became a subject of contention. While inflation remained elevated, the banking crisis highlighted the vulnerability of the financial system to rapid interest rate increases. Complicating the Fed's path forward were robust US job growth (despite cooling wages) and a 0.5% monthly increase in "core" consumer price growth (although annual headline CPI inflation fell to 6.0%). Ultimately, the Fed raised rates by 25 basis points, aligning with market consensus. However, the Federal Open Market Committee suggested that it may soon conclude its monetary tightening campaign. This led to a late recovery in the technology sector, resulting in the NASDAQ composite index recording its best quarter since 2020. Among sectors, communication services, information technology, and consumer discretionary performed well, while energy and financials lagged behind.

Asian equities saw gains in March, driven by leading contributors like China, South Korea, and Taiwan. The turmoil in the US and European financial systems had limited spill-over effects in the region, aided by indications of reduced monetary tightening by the US Federal Reserve (Fed). Chinese equities ended the month on a positive note, thanks to Beijing's support for the internet and gaming sectors, improved global financial conditions, and eased geopolitical tensions. State-Owned Enterprise (SOE) reports positively surprised investors, leading to strength in telecommunications, oil, and construction industries. Although Europe's banking crisis initially raised contagion concerns, its impact on Asian financials remained limited. Chinese economic growth, combined with an unexpected 25-basis point rate cut by the People's Bank of China, contrasted with rate hikes by most developed market central banks. The technology sector experienced a rebound, driven by Alibaba's restructuring news and signs of reduced regulatory scrutiny. Taiwan and South Korea's equity markets performed well, with the former benefiting from indications of the Fed's potential shift in monetary policy and the latter seeing a rally in battery stocks and technology sector recovery.

Emerging equity markets showed positive performance overall, with Asia leading the way, followed by Latin America and Europe, the Middle East, and Africa (EMEA). EMEA markets traded flat as they contended with the turmoil in the European banking sector. Saudi Arabia and China were the best-performing markets, while Turkey and the United Arab Emirates (UAE) experienced the most significant declines. Asia's rise was driven by improving sentiment in China's internet and gaming sectors, along with continued reopening and recovery, including increased international flights and housing transactions. In EMEA, the closure of US regional banks initially impacted Credit Suisse but was mitigated by its merger with UBS, which restored confidence in banking shares and the broader equity market. Saudi Arabia's outperformance resulted from the country's decision to restore ties with Iran during a China-hosted summit. Czech Republic equities performed well, primarily driven by the utilities sector, outperforming neighboring countries like Poland and Hungary. Turkey faced challenges, with weakened currency and declining materials and industrials sectors. In Latin America, Argentina underperformed the region due to uncertainty surrounding upcoming elections and a current drought. Mexico and Peru were the only countries that outperformed the region, with the former benefiting from positive macroeconomic indicators such as increased retail sales, services activity, and domestic demand.

Bond markets experienced significant volatility during the month, triggered by the collapse of Silicon Valley Bank (SVB) and UBS's takeover of Credit Suisse. This turmoil led to sharp price movements and raised concerns among investors about further interest rate hikes by central banks to address inflation. However, towards the end of the month, financial markets calmed down, and investors became less worried about aggressive rate increases, resulting in a rally in government bonds.

US treasuries, UK gilts, and German bunds all posted gains in March. US treasuries returned 2.96%, while UK gilts and German bunds returned 3.03% and 2.41% respectively, according to data from ICE BofA. Prior to the SVB news, market focus was on inflation persistence and the likelihood of the US Federal Reserve (Fed) increasing the pace of rate hikes. Fed Chair Powell's testimony supported these expectations, pushing the estimated terminal rate of the Fed to a new high of 5.69%. Despite the banking turmoil, the Fed followed through with a 25 basis point rate hike to 4.75%-5.00%. However, the risk-off sentiment resulting from the banking sector issues led to expectations of US interest rates peaking below 5.0% and even raised the possibility of rate cuts in the second half of 2023.

In terms of economic news, US inflation eased in February, dropping to 6.0% from the previous month's 6.4%. Eurozone inflation also fell more than anticipated, primarily due to lower energy costs, with consumer prices rising by 6.9% in the year to March compared to February's 8.5%. However, core inflation, excluding volatile items, reached a new eurozone high of 5.7%. The European Central Bank proceeded with its planned 50 basis point interest rate increase, raising the deposit rate from 2.5% to 3.0%, while data indicated that the eurozone's business activity recovery was gaining momentum, alleviating concerns of a recession.

The UK economy showed signs of recovery, with growth picking up across all sectors after a period of uncertainty. However, inflationary pressures persisted as food prices rose unexpectedly, particularly due to a shortage of salad items, leading to a consumer prices index (CPI) increase of 10.4% in February. The Bank of England responded by raising interest rates from 4.0% to 4.25%, marking the 11th consecutive rate hike.

Despite some spread widening, investment-grade credit had a positive return for the month, with US investment-grade bonds bouncing back strongly. The ICE BofA US Corporate Index returned 2.56% in March. Sterling and Euro Corporate indexes also advanced, returning 0.90% and 1.02% respectively. Credit spreads for GBP, EUR, and USD investment-grade credit moved higher. In the high-yield market, performance was mixed, with the ICE BofA US High Yield (HY) index returning 1.13%, while the European Currency High Yield index declined by 0.41%. Credit spreads widened for €/£ high-yield bonds, while dollar-denominated high-yield bonds saw an increase.