Markets in a Nutshell — July 2023

Risk assets rallied again in July, adding to the robust gains achieved in the first half of the year. Early investor worries over everything from US bank failures to global recessions have seemingly faded. We are now seeing a transition from fear back to greed — fuelled by resilient US economic data, slowing headline inflation globally and the enthusiastic buzz around artificial intelligence. Returns were positive across most asset classes and geographies. In a reversal of fortunes, emerging market equities dramatically outperformed their developed market peers in the month. 

In the US, the rally was supported by continued labour market strength, cooling inflation and better-than-expected corporate earnings. In Europe and the UK, the gains were also driven by slowing inflation. However, while the Eurozone shows encouraging signs of economic growth, the UK outlook is mixed, with several gauges still suggesting stagnation.

Asian equities led the July rallies after the Chinese government announced its intention to boost sluggish growth by introducing new initiatives to increase consumption. Given its attractive equity valuations, the region doesn’t necessarily need a sharp recovery to deliver impressive returns from this point. However, some economic stimulus might be a catalyst to get a wider cohort of global investors back into the region.

The Foord International Fund achieved decent growth in the month, despite its moderate S&P 500 hedge. The Foord Global Equity Fund outperformed the benchmark on Chinese equity market strength, while the Foord Asia ex-Japan Fund is showing continued alpha this year and since its inception two years ago. We remain excited for its prospects.

Part of the reason why the US economy has remained resilient despite sharp interest rate hikes is that the US labour market remains strong, with the unemployment rate still at an astonishingly low 3.5%. However, this is a double-edged sword: wages and jobs growth are also critical contributors to core inflation. Hourly earnings growth came out stronger than expected at 4.4% year-on-year — well above levels considered consistent with the US Federal Reserve’s 2% inflation target.

Headline inflation is falling in most regions because the worst effects of the pandemic and the war in Ukraine have eased — not because of central bank hawkishness. Prices of energy and food staples, such as natural gas and wheat, are considerably lower than their peaks a year ago, but these exogenous inflation drivers are beyond the control of central bankers. Core inflation — which excludes volatile food and energy items — remains well above target levels.

So, in contrast to the market’s unbridled optimism, we remain cautious on the inflation and interest rate outlook. Current data does seem to suggest a soft landing, but therein lies the problem: today’s data tells us more about central bank policy 12 months ago (when the interest rate hiking cycle had just started) than it does about today’s policy settings.

The lagged impact of the aggressive central bank rate hikes and tightening of credit conditions is still working its way through the system. With a typical lag of four to six quarters for the impact of higher rates to be felt, there is still significant uncertainty around the full impact of aggressive interest rate hikes on the US economy especially. Crude oil prices were also resurgent this month, rising more than 14% to over $80 per barrel. For these reasons and more, the inflation threat remains, meaning interest rates are still likely to remain higher for longer than the market expects.

With much of this year’s returns in the US driven by multiple expansion within a narrow group of stocks, our funds remain conservatively positioned to the frothiest areas of the US equity market. Since the gains in Big Tech stocks were the main engine behind this year’s stock market rally, if tomorrow’s earnings don’t live up to today’s lofty valuations, they could also — as easily — lead the market’s decline.

Above all else, we remain focused on buying quality businesses underpinned by strong fundamental moats and real cash earnings, but which are also priced attractively. Our conviction lies in companies that meet our fundamental investment criteria while offering adequate downside protection and good value.

Our goal has always been two-fold: to protect investor capital and to grow returns meaningfully ahead of inflation over time. Over more than 40 years — we are proud to say — our process has delivered on both. At present, it remains prudent to position our portfolios conservatively. Though we remain vigilant, we are also excited about the many opportunities that lie ahead.