May Market Commentary

14 Jun 2023 | Investment Updates

May was a month characterised by concerns over a possible catastrophic US default on its debt obligations, with markets waiting to see if a bipartisan deal could be reached on the debt ceiling and pass through Congress before the end of the month.

Inflation data and interest rates continued to be under the microscope as markets looked for a return to ‘normal’ levels of inflation and started to consider potential future moves from central banks on further hikes or even cuts.

 

The US Debt Ceiling

The USA has a hard limit on the gross amount its government can borrow, known as the debt ceiling. Once the limit is reached, the government can no longer borrow money or pay its current debt obligations. If the US were to default, it would be catastrophic and cause seismic waves in markets. This is why markets were nervy during May, as the first week of June would see the US breach its debt ceiling and default unless a deal could be made.

Successive US governments, both red and blue, have always raised or suspended the debt ceiling in the past. The last time it was this close to reaching the limit without a deal; however, in 2011, it caused some shockwaves through the market and even saw the US have its credit rating downgraded. With US politics becoming more and more partisan, investors were understandably nervy that a deal could be reached.

President Biden and House Majority Leader Kevin McCarthy maintained a generally positive tone during the negotiations. However, there were still some unresolved sticking points. The US debt ceiling stood at $31.4 trillion, or 117% of GDP, and Republicans wanted to see government spending reined in so that borrowing could be reduced over the coming years. President Biden, however, needed borrowing to fund many of his flagship policies, particularly on suspending student loan debt. With the US presidential elections due next year, both sides needed a deal they could claim as a win. However, the partisan nature of Congress meant there was a chance that hardliners from both parties could scupper any deal.

Ultimately, Biden and McCarthy were able to reach a deal that passed through Congress. Hardliners couldn’t garner enough support to stop it in its tracks, which ultimately proved important as the deal was only reached with days until the deadline. Interestingly, more Democrats voted for the deal than Republicans in the House of Representatives, despite a Republican majority.

The deal sees the debt ceiling suspended, rather than raised, until January 2025. This is after the 2024 presidential election; therefore, the US will not be at risk of default during the election cycle. The deal sees defence spending increase to $886 billion, which aligns with Biden’s previously proposed defence budget. However, the administration will have to cut back on non-defence discretionary spending – this will be flat in 2024 before increasing only 1% in 2025. This will see caps for spending on domestic programmes such as housing, border control, and scientific research, amongst others. Spending to reform the IRS will also be reduced, a key win for Republicans, who generally believe in a lower tax regime compared to Democrats.

The deal had enough for both sides to score political points, and markets reacted positively to the news. Having been generally flat for several weeks, the end of the month saw markets rise following the deal passing Congress.

 

The ‘I’ Word – The USA

Inflation remains the bugbear for markets; however, some positive signs are appearing, particularly in the US. CPI fell to 4.9% in April, below expectations and the 10th consecutive month of falling inflation (it should be noted, however, that prices are still rising, just at a slower pace than they were). Importantly, core inflation, which excludes food and energy, also fell to 5.5%.

Unfortunately for the US, one of the drivers of inflation is a growing jobs market. This means that wages are likely to rise, which could also become a contributing factor to inflation. We also are seeing a constrained labour supply, adding to production constraints. Worker shortages mean demand cannot be met comfortably, so wages are driven up to attract workers. Many developed markets are struggling with this. The US has a labour participation rate below 63% whilst simultaneously adding another 253,000 jobs in April, followed by a further 339,000 in May. This means the US has now seen 29 consecutive months of job growth. Employment growth has generally slowed over the last year but is still increasing at an annualised rate of 1.7%. Wages also grew by 4% (average hourly earnings) in the three months to April.

Some cracks started to appear, with jobless claims rising to their highest since October 2021, but if the Fed wants to see the impact of their rate hikes on the economy, they may need to see more evidence of a slowing jobs market.

Fewer investors now expect any sort of rate cut from the Fed this year. In fact, the consensus suggests that the hiking cycle may not have ended as first thought. Instead, the expectation is that June could be only a ‘pause’, and a further hike may come in July. This, of course, will depend on data for the next couple of months before the Fed makes this decision, but any further hiking would likely be seen as negative by the market. It may be that the best of the year’s returns have already been seen. Markets could be headed for a nervy period until rate cuts happen, which is now more likely than not to be at some point in 2024.

 

The ‘I’ Word – The UK

Elsewhere, UK inflation data for April fell to 8.7%, ending the spell of double-digit inflation. Whilst this appears to be good on the surface, inflation was still above expectations of 8.2%. When core inflation is considered, this actually rose significantly. Having been expected to remain at 6.2%, it went up to 6.8%, its highest level for 30 years. This is because although headline inflation is falling, it is broadening across UK sectors rather than contracting. Strong services sector wage growth, falling commodity prices, and improved pricing power are creating an inflation problem in the UK with domestic drivers. The Chancellor, Jeremy Hunt, has backed rate hikes from the Bank of England to combat inflation, even if it pushes the UK into recession.

The Bank of England made a record-breaking 12th consecutive rate hike to bring interest rates to their highest level since 2008, at 4.5%. Markets expect at least another two hikes by November, and the latest inflation data had seen the terminal rate pricing increase to 5.5%, which is 0.4% higher than before the April data was released.

The UK has also seen house prices falling at the fastest annual rate since July 2009. According to Nationwide, prices fell 3.4% year-on-year in May. This followed an unexpected increase of 0.5% in April; however, this is the only month out of the last eight where house prices increased. 

One area of (small) good news for the UK was that the BoE’s Monetary Policy Committee updated its forecast for the UK economy, saying that growth for the year should be 0.5% instead of a marginal recession. 

 

The ‘I’ Word – The Eurozone

 Eurozone annual CPI actually rose slightly in April, going up to 7%. The ECB raised interest rates a further 0.25% to 3.25%. ECB President Christine Lagarde said rates would go to “sufficiently restrictive levels” until inflation was back at the bank’s target of 2%.

The growth of the eurozone economy slowed in the first quarter, seeing growth of 1.3%, which was lower than the previous three quarters.
Germany became the first major economy to fall into a technical recession, with GDP contracting 0.3% in Q1, following a 0.5% decline in Q4. Germany’s annual inflation rate of 7.2% is higher than the eurozone average.

 

China’s Post-Lockdown Bump – Not What It Appears? 

Last month we looked at the Chinese recovery post-lockdown; however, it may be that it is, in fact, not as strong as it first appeared. The bump may have been short and sharp rather than indicative of the future. 

Industrial production rose year-on-year but by less than expected at just 5.6%. Retail spending also only increased by 18.4%. For context, the figures compare to last year’s point when Shanghai went into an extended lockdown. Given that economic activity was severely restricted in the previous year, many expected to see much better figures coming out of China. Economists have now revised downward estimates for Chinese growth this year. China’s central bank is also likely to reduce major banks’ reserve requirement ratio earlier than expected to try and boost economic activity.

Chinese stocks, bond yields, and currency are also continuing to be impacted by Covid. Whilst no significant announcements have been made, several articles appear to indicate that China may be seeing daily new Covid infections of 65 million.

The conflict between China and the US over technology, particularly microchips, also rumbles on. Apple announced that it agreed with Broadcom, a US semiconductor manufacturer, to supply 5G components for the iPhone. Apple CEO Tim Cook said that “all of Apple’s products depend on technology engineered and built” in the US. This agreement reduces reliance on Chinese parts of the supply chain.

China has also banned microchips from US company Micron being used in the country’s infrastructure development, citing security risks. The microchip race is seeing more and more technology protectionism from the West and China.

Chinese tech has also been under the spotlight in Montana. TikTok owner ByteDance is filing a lawsuit to fight the state banning new app downloads. 

Despite the bad news, China did, in fact, become the world’s biggest exporter of cars in Q1, overtaking Japan (1 million exports versus 950,000). China has been expanding its production of electric vehicles, and this accounts for most of its exports.

 

Japan Goes Back to the 90s

The Tokyo stock index (TOPIX) rose to a 33-year high on the back of data showing that the Japanese economy grew by an annualised 1.6% in the first quarter, outpacing US growth. This level was last seen in 1990, one year after the stock market peak of 1989. Domestic demand has increased, but the reopening of borders post-Covid has seen the country benefit highly from a recovery in tourism. Investors will watch to see if an all-time high can be reached, as the market appears to slowly be edging in that direction.

Whilst the TOPIX peak has been long surpassed if the index is converted into USD or GBP terms, a new peak in local currency would be seen as a big psychological win to attract more investors into Japanese equities.

 

Energy Markets

Fears of global recession have been weighing on oil markets, as a reduction in economic activity would lead to a decrease in demand for oil. BP saw its annual profits in Q1 fall from $6.2 billion to $5 billion. In comparison, Shell and Chevron improved to $9.6 billion and $6.6 billion, respectively. Saudi Aramco’s net profit also fell by 20% year-on-year; however, it still made $32 billion. Despite falling prices, oil and gas giants continue to do well despite recent energy prices.

The price of natural gas in Europe fell to its lowest level since July 2021. This was driven by the successful sourcing of alternative energy sources to Russia, plus a mild winter leaving gas stockpiles in good shape.

 

In Other News

Shares in Alphabet surged following its unveiling of a new AI-based search platform. US tech stocks hit 2023 highs, with the Nasdaq index seeing a nine-month high. Tech stocks are also driving S&P 500 performance; their removal would see the index having struggled this year.

 A surge in Nvidia’s share price pushed it briefly past $1 trillion in stock market value. The American company makes high-performance chips used in artificial intelligence and has seen its stock double in value since the release of ChatGPT last November.

Less than two months after filing for bankruptcy protection, Virgin Orbit was wound down. A sale of the rocket-launch company’s assets fetched just $36 million, around 1% of the $3.7 billion it was valued at when it floated on the NASDAQ in 2021.

Go First, a discount airline in India, entered bankruptcy protection, blaming the grounding of half its fleet on problems with Pratt & Whitney engines – an issue affecting other Indian airlines. This came soon after news that domestic air travel in India hit a record high as 456,000 passengers flew in a single day. More than 37.5 million people travelled by domestic airlines in the first quarter, up by half compared with a year earlier. 

Chinese media heralded the inaugural commercial flight of the c919, a passenger jet built by Comac, a state-owned plane maker. The c919 is touted by the Chinese government as a potential rival to Airbus and Boeing in China’s aviation market, stressing the country’s technological independence in the face of some American sanctions. The first flight was operated by China Eastern from Shanghai to Beijing. Comac already has 1,000 orders for the plane, according to state media.  

 

Sources
  • BlackRock Investment Institute
  • atomos, via VAM Funds
  • Fidelity International
  • Canaccord Genuity Wealth Management
  • RBC Brewin Dolphin, via Guinness Asset Management
  • BBC
  • US Bank

 

 

The Rise of AI

As an exercise of interest and curiosity, I decided to ask ChatGPT for its summary of financial markets for the month of May 2023, and this is what it said:

“May 2023 was a month marked by increased volatility in global financial markets. Inflation concerns, central bank actions, geopolitical tensions, and corporate earnings reports played significant roles in shaping market sentiment. The cryptocurrency market experienced substantial volatility, while the energy sector faced uncertainty due to production decisions and geopolitical factors. Additionally, the rise of sustainable finance and green investments indicated a growing focus on ESG considerations. As the markets remained sensitive to various economic factors, investors continued to navigate a challenging landscape while seeking opportunities and managing risks.”

On asking further, it informed me that its database only goes up to September 2021 and, therefore, could not provide any more detailed information. This confirmed my initial thoughts – it had just replied with a generic response that would likely capture an overview of what might be happening in markets. The tool has lots of potential but still has some way to go. What it means for me is that my writing of these market commentaries will have to continue without any AI assistance, which I suppose makes me feel safer about the future.

April Market Commentary

April was the first negative month of the year. Stubbornly high inflation readings weighed on markets as the prospect of cuts to interest rates weakened, with most now expecting that they will not happen until the back end of the year, if at all, during 2024.

March Market Commentary

Markets were subdued for the beginning of March, with an eye to inflation data and central bank policy decisions, but ended the month optimistic of rate cuts to come later this year, even if fewer in number than had been hoped for in last year’s projections.

February Market Commentary

Stock markets maintained robust performance throughout February, with the MSCI World Index gaining an additional 4% for the month. This brought its year-to-date performance to a positive 5.3% return.