Market Analysis Jun 2023

US equities concluded the quarter on an upward trajectory, with most gains recorded in June. The rise was supported by moderating inflation and indications of the US economy's resilience despite higher interest rates. A revision of Q1 GDP growth revealed a 2% expansion (annualized), surpassing the earlier estimate of 1.3% growth.

The Federal Reserve (Fed) raised interest rates by 25 basis points (bps) in May but maintained rates in June, exhibiting a "hawkish pause." The rate predictions in the "dot plot" suggested two more rate hikes in 2023.

US inflation, as measured by CPI, declined to 0.1% (month-on-month) in May, easing from April's 0.4% increase, driven by declining energy costs. The annual inflation rate dropped to 4.0%, lower than the projected 4.1%. Despite an unexpected increase in the unemployment rate from 3.4% to 3.7% in May, the labor market remained tight.

Concerns regarding the US debt ceiling emerged at the start of the review period but were resolved through legislation that suspended the debt ceiling in early June. The legislation included concessions on spending that were unlikely to significantly affect economic growth.

The information technology (IT) sector led the stock market growth during the quarter, propelled by AI fervor and the potential for technology advancements. Consumer discretionary and communication services sectors also demonstrated strong performance, whereas energy and utilities sectors lagged.

Eurozone shares experienced gains in Q2, primarily driven by the financial and IT sectors. Conversely, energy and communication services sectors underperformed.

Semiconductor stocks boosted the IT sector, with higher-than-expected sales projections from US chipmakers emphasizing AI's growth potential. Additionally, the Dutch government's announcement that high-end chip manufacturing machines would require licenses for overseas shipment added to the sector's momentum.

The European Central Bank (ECB) implemented two interest rate hikes in the quarter, raising the main refinancing rate to 4.0%. Headline inflation decreased, with an estimated 5.5% annual inflation rate in June, down from 6.1% in May. However, core inflation (excluding energy, food, alcohol, and tobacco prices) slightly increased to 5.4% in June.

GDP data indicated a mild recession in the eurozone over the winter, with Q4 2022 and Q1 2023 experiencing declines of -0.1%. Forward-looking data hinted at a slowdown in eurozone economic momentum, as the flash eurozone composite purchasing managers' index (PMI) fell to 50.3 in June from May's 52.8. This suggests the economy could be nearing stagnation.

UK equities declined during the quarter, driven by diversified energy and basic materials groups. Weakness in commodity prices and concerns about China's economic outlook, coupled with sterling strength, weighed on these sectors. Domestically focused areas of the market also underperformed.

The Bank of England (BoE) implemented two rate hikes, with the June increase of 0.5 percentage points signaling an accelerated rate of rate hikes after a slower pace in March.

Stronger-than-anticipated UK jobs data, wage growth, and core inflation readings contributed to the BoE's decision to accelerate rate hikes. The sell-off in UK gilts, leading to rising yields, reflected questions about the UK's inflation outlook.

Sterling's performance influenced UK domestic economy, impacting "swap rates" used to price fixed-rate mortgages. Despite concerns about inflation, yields on longer-dated gilts fell following the June rate hike, suggesting investors' increased belief in the BoE's ability to control inflation.

Japanese shares sustained strong momentum in June, leading to a 14.4% rise in the TOPIX Total Return index for Q2. The Japanese yen weakened further against major currencies, affecting foreign currency-denominated returns.

The Nikkei reached a 33-year peak at 33,700 yen in June, driven by continuous foreign investor buying since April. Expectations of corporate governance reforms and structural shifts in the macroeconomy contributed to market gains. Yen weakness and the US market's strength also boosted the Japanese equity market.

The Bank of Japan (BOJ) maintained its dovish stance in April and June policy meetings. The US Fed's ongoing interest rate hikes contributed to yen weakness. Macroeconomic indicators suggested solid progress in Japan's inflation and wage growth.

Asia ex Japan equities experienced negative growth in the second quarter. China, Malaysia, and Thailand had the lowest-performing index markets, while India, South Korea, and Taiwan recorded gains.

Chinese equities declined due to cooling economic rebound after the post-Covid reopening. Slower factory output resulted from weak consumer spending and reduced export demand following interest rate hikes in the US and Europe. Hong Kong shares also fell due to concerns over China's economic slowdown.

India's equities gained significantly from foreign inflows and stable earnings, while Taiwan advanced due to technology stocks. South Korea, the Philippines, and Singapore ended the quarter negatively, with Indonesia achieving modest gains.

Emerging market (EM) equities delivered modest gains, lagging behind developed markets. Tensions between the US and China, concerns about China's economic recovery, and US debt ceiling uncertainty contributed to EM underperformance.

Hungary, Poland, and Greece outperformed despite Europe's rising recession fears. Central European markets anticipated rate cuts as inflation eased, with Hungary implementing a rate cut in June. Greece's performance was driven by the ruling New Democracy party's re-election, indicating market-friendly policies.

Brazil's performance improved due to easing fiscal policy concerns and optimism about rate cuts. India experienced strong gains from foreign inflows and positive macroeconomic data.

China underperformed as concerns persisted about its economic recovery. South Africa's declining power situation led to economic growth concerns, while Turkey faced losses following President Erdogan's re-election.

The second quarter of 2023 witnessed reduced market volatility. Government bond yields increased, but divergence occurred, with the UK and Australia underperforming due to higher-than-expected inflation and stronger inflation-combat measures by central banks.

Major central banks continued to raise interest rates throughout the quarter. The US Federal Reserve, however, paused in June after a year of consecutive rate hikes, maintaining rates between 5% and 5.25%.

Corporate balance sheets remained robust despite some increase in default rates. Global high yield outperformed investment grade, and immediate recession concerns abated.

US growth exceeded expectations, leading to negative total returns for US investment grade but positive returns for US high yield. The US 10-year yield rose from 3.47% to 3.81%, with the two-year yield climbing from 4.03% to 4.87%.

The ECB's interest rate hikes continued, but headline inflation decreased significantly. Germany's 10-year yield increased from 2.31% to 2.39%, while Euro high yield outperformed investment grade.

Surprising inflation trends in the UK prompted the BoE to raise rates by 50 basis points in June. UK 10-year yields jumped from 3.49% to 4.39%. Sterling outperformed, while the Japanese yen weakened.

In Q2, convertibles, measured by the Refinitiv Global Focus Index, returned 5%. Convertibles benefitted from the strong performance of "big tech" stocks driven by the AI narrative. The primary market was active, with $22 billion in new convertibles entering the market. However, the universe lacked some major tech names, limiting full participation in stock gains.