Market Analysis Sep 2023

The downturn in global bond markets added to the strain on riskier assets, with the global bond benchmark dropping 3.6% in the third quarter. The US Treasury market lagged behind. However, the lower interest rate sensitivity of high-yield bonds allowed both the US and European markets to see gains, with returns of 0.5% and 1.5% respectively. Amidst falling stocks and bonds, commodities stood out with a 4.7% return, mirroring 2022’s trends

Japan led the equity markets in local currency, boasting a 2.5% quarterly return and continuing its positive trend. A weakening yen provided a boost, though Japanese officials expressed discomfort with the level of depreciation this year.

The UK followed closely, with a 1.9% return, partly due to its lean towards the energy sector which benefited from surging oil prices. Elsewhere, returns were mostly negative. Concerns over China's property sector impacted emerging markets, despite new policies aiming to stabilize the housing sector.

Government bonds saw negative returns in developed markets as yields climbed. UK Gilts, though lagging yearly, returned -0.7% over the quarter as changing growth data adjusted interest rate expectations.

The high-yield bond sector shines this year, with the US and Europe benchmarks seeing 6.0% and 6.1% returns so far. Their shorter-term nature has been an advantage in a rising yield scenario.

The joint decline of stocks and bonds this quarter recalls 2022, but the underlying factors differ. Economic indicators suggest a weakening growth trajectory. With declining inflation, there's growing belief that the peak in rate hikes is nearing, as discussed in our recent piece, “Beyond the pause: What happens after peak rates”.

The discussion has shifted towards the duration of central bank rate holds. Many believe a "higher for longer" approach is essential to manage persistent inflation. The sustainability of fiscal policies worries bond investors, especially with the US Treasury market's concerns over sustaining significant fiscal deficits. Additionally, tight oil markets have become a concern as Brent crude oil prices jumped 28% this quarter, primarily due to Saudi Arabia and Russia's decision to maintain oil output cuts. Rising oil prices may impact consumer spending and might challenge central banks if inflation accelerates, a concern to watch closely.

In summary, the favorable conditions for risk assets earlier this year faced inevitable challenges given the global economic slowdown. While the economy has shown resilience, the possibility of a recession looms, and the market may not be adequately priced for it. The shift in fixed income yields indicates that core bonds might act as a safeguard if diminished growth tempers inflation. However, the recent correlation between stocks and bonds emphasizes the value of alternative assets that can diversify against various risks.