Another month, another painful set of UK inflation numbers. Confounding the consensus view that Consumer Price Index (CPI) inflation would fall a little to 8.4%, it remained ominously sticky, unchanged on the previous month at 8.7%. More worrying was the ‘core’ inflation figure, which excludes components where prices vary considerably from month to month such as food and energy. For a second month, it rose unexpectedly, from 6.8% to 7.1%, the highest rate for more than 30 years.
Jolted into action, the Bank of England lifted interest rates by 0.5%, more than the previously- anticipated 0.25%, in an attempt to rein in rampant price rises. It takes the current base rate to 5%, and the Bank is now signalling it will need to push rates higher still. Some commentators think as much as 6.5% will mark the peak, though Governor Andrew Bailey recently said he thought it would be “less than currently priced in financial markets".
Higher rates take their toll
With the Bank sounding the alarm on inflation, gilt (UK government bond) prices fell and yields rose. However, the effect was most acute among shorter-dated bonds with one to two years until maturity where the prevailing short-term rate of interest is closely tied to the BoE’s rate. As I write the one-year gilt yield continues to probe new highs at close to 5.5% and the two-year bonds yield 5.4%. Further out, 10-year UK government bond yields aren’t as high. They trade around 4.4% at present, slightly down from the 4.5% they reached a couple of weeks ago. Funds in the gilt sectors, and especially the index linked sector, are generally oriented towards the long end of the curve, which is why they were somewhat resilient over the course of the month.
The spill-over from higher interest rates has most obviously resulted in the higher cost of borrowing for businesses and homeowners. However, many investors have lost out too. Besides being a headwind for bonds, interest-rate sensitive areas such as REITs and infrastructure investment trusts have been under pressure, especially those with gearing (borrowing to invest). More broadly, any company with significant debt is increasingly coming under investors’ microscopes. Gold too, sometimes a hedge against inflation, has faded as short-term interest rates have risen.
A narrow market
Turning to global stock markets, relative sanctuary was found in some of the more niche areas such as Japan, India, China and Latin America. However the US technology giants mostly gave back some of the gains of recent months, their strength having been a chief characteristic of the first half of the year.
A narrow band of stocks, the so-called ‘magnificent seven’ (Apple, Microsoft, Nvidia, Tesla, Alphabet, Amazon and Meta) have dominated returns from global market indices, pulling them out of 2022’s bear market. The S&P 500 is up around 15% year to date, but without these seven there would be hardly any rise at all. The Nasdaq, meanwhile, which is more concentrated in these seven companies, is up around 30% year to date.
The rest of the US market, along with other global markets, have more or less gone nowhere over the first six months of the year. The magnificent seven are seen as offering growth in a low growth world, and a number of them stand to benefit from advances in AI, a narrative that has captured investors’ imaginations. Is this tight leadership a mini bubble? High valuations and a popular narrative are certainly concerns, but there are also logical reasons investors have corralled into this small band of stocks. For instance, they are not immediately seeing the effects of higher interest rates or an increasingly fatigued consumer.
UK a laggard once more
Relative underperformance continued for the UK sectors. Following a decent start to the year, the FTSE 100 is now slightly lower with resources and commodity stocks weighing. Much of this is down to weaker growth in China and investors dialling back expectations for the world’s second largest economy, though it showed a bit more strength in June. Instead it was financials and more domestically-oriented stocks that came under most pressure.
While UK valuations look enticing, the sentiment of both domestic and overseas investors remains febrile. Unsurprising, perhaps, in face of the more persistent inflationary outlook and an economy facing the headwind of higher interest rates taking their toll on consumers and businesses. However, it may be the resilience of company earnings, and the scope for increasing merger and acquisition activity, provide some positive surprises over the coming months and help support the market.
Although investors should be aware past performance is not a reliable indicator of future results, here are the top and bottom ten Investment Association (IA) funds and sectors* for June 2023:
Top ten funds:
Bottom ten funds:
Top ten sectors:
Bottom ten sectors:
The value of investments can fall as well as rise. Investors may get back less than invested. Past performance is not a reliable guide to future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, data for June 2023: 31/05/2023 to 30/06/2023. Onshore and retail open-ended funds only.
*There are several thousand funds on sale in the UK. The Investment Association divides these into about 45 sectors, broad groupings that help investors and advisers compare funds of similar types before looking in detail at individual funds.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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