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The sense of optimism which prevailed in financial markets during January pretty much evaporated in February. As we expected, the inflation dragon has not been defeated as data from both the US and Europe through the month clearly demonstrated. Markets had reached a point of high confidence in relation to just how high interest rates would rise and how soon they would start to reverse. Recent inflation data has shaken that confidence. While it would appear that goods prices have steadied considerably this is not the case with wages. In the US, Walmart, seen as a bellwether for the US retail sector, increased its minimum wage to $14 per hour while in the UK and Germany, public sector unions have started agitating aggressively in relation to pay. These developments will inevitably lead to a certain level of inflation becoming embedded in economies which may also result in interest rates rising to higher level than previously thought. Central banks will certainly have their work cut out to stay ahead of all this without tipping economies into recession. For financial markets, the pattern for the coming months is likely to be one of volatility.
Despite the growing uncertainty, European markets moved in a positive direction in February while the US ended up flat. This was driven by a perception (to a significant extent among US investors) that Europe represents good value on a relative basis. We would expect that valuation levels in Europe will continue to act as a support for that market over the short to medium term. In many ways the surprising market over the past month was China. Thanks to the post covid reopening, China’s manufacturing sector expanded at the fastest pace in more than a decade in February. Despite this, the market fell by almost 8% in euro terms over the month. The value case for China is as strong as it has been in a very long time but unfortunately political considerations and debt overhangs will continue to cast a shadow for a while yet. Overall, we remain cautious on the outlook for equities over 2023 and continue to favour ‘value’ stocks over more highly valued growth stocks. We also favour Europe and Emerging Markets over the US.
Equity Market Performances (percentage change in euro terms)
|Market||Performance Feb 2023*||Performance 1 year*||YTD*|
*Source: Financial Times, Financial Express
Inevitably the back and forth on inflation brought volatility to bond markets too. The Harvest bond fund peer group suffered an average fall in value of 1.6% over the month, giving back most of the gains notched in January. That said, we remain firmly convinced that there is plenty of value in bond markets at current levels with many broadly spread bond funds offering running dividend yields of 5% and more with low levels of inherent risk. We like investment grade bonds and the BB bond class in the High Yield bond space with both of these groupings currently offering investors a very attractive risk/reward mix.
We turned cautious on office property some time ago and we believe that demand will remain weak for quite some time, both in Ireland and overseas. Demand remains very strong for residential across the developed world although there are signs of weakening in the US as the interest rate increases take effect. The rate rise effect is still not really evident in Europe (apart from the UK) but could begin to take a toll over the coming months. However, the market uncertainty has driven many global REITs to trade at very sizeable discounts and as a result we see very good value in property sub-sectors away from retail and offices.
With volatility likely to remain a feature in mainstream asset markets, we remain very pro Alternatives as essential components of any portfolio. Sectors such as renewables, infrastructure and hedge funds can deliver relative stability and, in many cases, high yields and could act as a steady bulwark against volatility elsewhere.
Our Fund in Focus for March 2023 is Pacific Longevity and Social Change Fund
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