January Gains, February Pains: Market Review February 2023

Like January, February continues to show a positive correlation between equities and bonds albeit in an unfavourable direction.

As shown in Exhibit 1, the S&P 500, tracking US large companies, fell by 2.44%, along with the MSCI World IMI, which captures large and mid-cap companies in developed markets, falling by 2.36%. The MSCI Emerging Markets IMI, consisting of large and mid-cap companies in emerging markets, experienced a significant drop of 6%. Additionally, the MSCI All Country World IMI, representing both developed and emerging markets, fell by 2.78%. In the bond market, the Bloomberg Global Aggregate also saw a decline of 1.6%.

Exhibit 1: Indexes Performance February 2023

Both the equity and bond markets were hit by rising yields as the markets are pricing in a more aggressive rate hike by major central banks. Companies in emerging markets were further hurt by the rising US dollar as their revenues are primarily derived in local currencies.

Value continues to shine as stocks and bonds remain positive year to date.

In 2022, the Global Targeted Value strategy outperformed the MSCI World IMI Index by nearly 10%, and it has continued to outperform this developed market index. As of 28 February, the Global Targeted Value strategy has maintained its outperformance, with a 2.54% advantage over the MSCI World IMI Index, as shown in Exhibit 2. Due to the short-term nature of their earnings, value stocks are impacted less by rising yields than non-value stocks. Our ongoing efforts to assist clients in capturing the value premium remain steadfast.

Exhibit 2: MSCI World IMI vs DFA Targeted Value YTD Performance

The market is still sensitive to changing interest rate expectations.

At present, the primary focus of the major central banks is to tackle the upward trend in price levels. Consequently, the expectations regarding interest rates are the main driving force behind market movements, as these central banks wield the power to set the prevailing interest rates.

Investors are closely monitoring inflation data to gauge the extent of upcoming rate hikes by central banks, which is influencing market pricing. While the market is still pricing a higher likelihood of a 25 bps in the next rate hike by the US central bank, the probability of a more aggressive 50 bps rate hike has been creeping upward for the past 3 weeks.

Exhibit 3 shows the relationship between the S&P 500 and the probability of a 50 bps rate hike in the next Federal Open Market Committee (FOMC) meeting on 22 March. The chart shows that the widely followed US market index has been reacting negatively to a higher interest rate expectation.

Exhibit 3: S&P Sensitivity to Probability of a More Aggressive Hike (6 Feb to 2 Mar)

Brace for a prolonged period of increased and elevated interest rates.

Although the market is responsive to changes in interest rate expectations, these expectations themselves are highly influenced by important economic indicators like inflation and the unemployment rate. These indicators provide crucial insights into the direction of inflation and the potential future path of interest rates which have an impact on the economy.

As reported by the US Bureau of Economic Analysis, the core personal consumption expenditure (PCE), the Federal Reserve’s preferred measure of inflation, ticked up for the first time in 4 months in January, as shown in Exhibit 4.

The data was released on 24 February following the Fed Chair’s, Jerome Powell, cautionary speech on 1 February regarding the gradual and challenging nature of the disinflationary process, which involves reducing inflation.

Exhibit 4: US PCE Core Inflation (Sep’22 to Jan’23)

Despite the slowdown in the increase of prices for goods, prices for services have remained resistant to change. The Chair of the Federal Reserve has stressed the significance of “Core services less housing” as an indicator for projecting the future path of core inflation since it primarily reflects alterations in labour wages, which constitute a considerable part of the cost structure for services.

Exhibit 5 offers a comparison of the components of core PCE inflation, which reveals that “Core services less housing” has maintained a steady range of 4-5% for over 18 months, starting from October 2022. Consequently, the projections for US interest rates may continue to rise during the upcoming FOMC meeting and remain high.

Exhibit 5: Components of Core PCE Inflation

In Europe, January’s headline inflation came in at 8.5%, exceeding the anticipated rate of 8.3%, while core inflation was 5.6%, surpassing the projected 5.3%. Following the release of this data, Christine Lagarde, Head of the European Central Bank (ECB), suggested that further interest rate increases may be necessary, in addition to the half percentage point hike that the ECB had signalled for later this month.

Further East, in addition to a near-zero interest rate, Japan has implemented a yield curve control policy that involves purchasing and selling bonds to limit the fluctuation of its 10-year government bond to within half a percentage point. This accommodative monetary policy aims to keep demand strong and maintain low borrowing costs for Japan’s heavily indebted government. However, the country is currently experiencing a 40-year high in inflation, which has raised concerns for the Bank of Japan (BoJ) that inflation may become uncontrollable. Additionally, if major central banks continue to increase interest rates, it could lead to the depreciation of the yen and further exacerbate inflation. As a result, the Bank of Japan (BoJ) is facing a monetary policy dilemma. It may need to tighten its monetary policy and abandon its yield curve control policy, resulting in a rise in interest rates and the yield curve.

Due to the current global inflationary conditions, interest rates may rise and remain elevated, resulting in continued market volatility as seen in the market fluctuations observed during the months of January and February.

Wealth Planning: Take Action Where Action Is Needed

The investment industry operates under the premise that higher risks lead to higher returns, and the volatility in the market confirms the existence of a market premium. Therefore, remaining invested in the long run enables investors to withstand market fluctuations and reap this premium.

Although actively investing in financial markets can be expensive, engaging in active financial planning can provide benefits such as risk management and achieving financial goals.

While we cannot control unforeseen circumstances, we can create a plan to mitigate the impact of inflation and prevent it from hindering progress toward achieving your objectives. Reach out to our advisers on how you can better position yourself in the current environment of high inflation and uncertainty. Our Client Advisers are here to support you in safeguarding your retirement and wealth goals against inflation.

Warmest Regards,
Investment Team

We do not charge a fee at the first consultation meeting. If you would like an honest second opinion on your current estate plan, investment portfolio, financial and/or retirement plan, make an appointment with us today.

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