Markets have extended the strong start to the year, buoyed by easing inflationary pressures and a better-than-expected corporate earnings season. While we are not out the woods economically, we believe our portfolios are well positioned should some of the lurking economic headwinds eventuate.
April was another strong month for global markets, with MSCI World Index gaining 1.6%, led by a 1.9% increase in European equities and a 1.5% rise in US equities. The prospect of less restrictive monetary policy supported markets, with data showing that inflation has continued to weaken.
US Personal Consumption Expenditure inflation retreated to 4.2% year-on-year in March, down from a peak of 7.0% last June. New Zealand CPI inflation data also came in cooler than expected in the first quarter, at 6.7% year-on-year, down from 7.2% at the last reading.
This cooling global economy has been a relief to central bankers, reducing the pressure to continually raise interest rates to curb inflation. This resulted in the US Federal Reserve indicating that they are finished with interest rate hikes for the time being. Expectations are that the Reserve Bank of New Zealand will raise interest rates by another 0.25%, but then pause on further increases.
Strong corporate earnings season
In addition to receding inflation fears, a stronger than expected earnings season in the US helped support markets. As large corporates published their earnings, the slowing economic environment wasn’t as apparent as investors had expected. So far 67% of companies have reported revenues that have exceeded expectations, and 80% have outstripped earnings expectations.
Big-tech results also helped investors shake off concerns. Facebook parent Meta Platforms led the way, with its stock jumping 14% in one day in late April after the social network reported its first sales increase in nearly a year. Earlier that week, Microsoft and Google parent Alphabet also reported stronger-than-expected results, boosting investor confidence. The combination of strong structural growth drivers in cloud, e-commerce and digital advertising for many of the largest tech companies – combined with the ability to reduce costs through headcount reductions - have led to these companies contributing significantly to share market gains in 2023.
Not out of the woods yet
While a cooling economy is good for inflation and interest rates, investors also need to be wary of the risks created by a slowing economy and high interest rates. Most economists expect cost of living pressures and higher interest rates to result in a consumer-led recession later in the year. A mild recession and slightly elevated unemployment may not be of too much concern for markets, but the scale of interest rate hikes by central banks does raise the risk of a hard landing.
How we’re positioning our portfolios for the year ahead
We are constantly reviewing our portfolios in response to emerging risks. In recent months we have been high-grading portfolios by reviewing any positions that have material levels of debt, economic sensitivity, or exposure to the property market. We are also focusing on companies that can grow under their own steam, even in a more challenging economic environment. In addition, with the rally in markets this year we are being increasingly sensitive to rising valuations - reducing our exposure to companies where valuations have become stretched.
In our fixed income portfolios, we have been reducing our exposure to corporate credit at the margin and allocating more capital to lower risk government bonds.
Despite being mindful of these risks and seeking to position portfolios appropriately, we are still finding plenty of attractive investment opportunities after last year’s market selloff. Valuations overall are still favourable, and we see good prospects for returns from here.