Markets in a Nutshell — for October 2023

Global stock markets fell for a third consecutive month, casting gloom over investors and making this Halloween more ‘trick’ than ‘treat’. Despite optimistic economic data, markets remain spooked by the prospect of central bankers keeping rates higher for longer to combat inflation. Markets fell across the board, with emerging market bourses (including those in China) falling most.

The US Federal Reserve’s aggressive rate hikes since March 2022 have reined in headline and core inflation prints from their 2022 peaks, but not yet to coveted target levels. Higher interest rates are nevertheless now starting to bite, with US bond market losses over the past year beginning to rival even the dot-com meltdown.

The US 10-year Treasury yield — a key benchmark for global interest rates — soared to 5% in October to a 16-year high. These levels heighten the risk of further financial contagion and dramatically raise borrowing costs for consumers and corporates. Higher ‘risk free’ rates also reduce the present values of future earnings streams — especially highly valued growth stocks promising juicy profits only far into the future.

Corporate profits were broadly resilient in the third-quarter earnings season, although some high-profile earnings misses added to the negative mood. Google parent Alphabet dropped almost 10% after narrowly missing revenue forecasts in one division. Facebook owner Meta — with the lowest valuation of the so-called ‘Magnificent Seven’ megacap tech stocks — sold off sharply despite solid earnings. Even companies that beat expectations, such as Microsoft, enjoyed only modest share price gains — a stark reminder that when stocks are priced for perfection, nothing else will suffice.

Prospects of a regional war in the Middle East drove a flight of capital to safe-haven assets such as gold, which closed near the $2,000/oz mark. Foord continues to hold gold bullion to hedge rising geopolitical tension and increased market volatility. In contrast, we continue to avoid diversified miners and platinum producers — both resource subsectors have come under immense pressure, given the commodity cycle downswing.

The Foord global funds disappointed. While short S&P 500 Index futures and the gold ETF helped to pare losses, the Foord International Fund was weighed down by big price falls of top-10 holdings FMC Corp and Freeport-McMoRan. Performance of the Foord Global Equity Fund was again hindered by its Chinese names, which fell on negative Chinese sentiment.

Foord’s investments in materials worked against fund performance this month. However, the materials names across the portfolios are increasingly focused on companies set to benefit from the global energy transition. They comprise companies whose earnings and cash flows are not only less cyclical than traditional materials peers, but also offer more certainty, irrespective of the future path of inflation and interest rates.

Despite the poor stock market sentiment, China’s economy gained momentum in the third quarter. Economic growth beat market expectations as Beijing stepped up support for the world’s second-biggest economy after a wobbly start to the year. Spending increased on everything from restaurants and alcohol to cars — helping to offset a drag from the property crisis and putting the 5% annual growth target in reach.

President Xi’s administration is trying to steer the Chinese economy away from debt-fuelled investments towards more sustainable growth, underpinned by consumer services and high-tech manufacturing. Foord’s global funds remain invested in high-quality Chinese technology and consumer discretionary companies, now trading at extraordinarily low multiples. We believe these investments will be vindicated in the next 12 to 18 months.

The US economy is also buoyant, expanding more than expected in the third quarter — primarily due to strong consumer spending supported by the robust jobs market. US economic resilience owes much to fiscal support — with the US deficit widening — coupled with consumers still withdrawing savings from pandemic-era stimulus. Both sources of support are now set to diminish, while the drag from tighter monetary policy should intensify. Already there is evidence of slowing credit growth, tighter bank lending standards and increasing delinquencies in US credit card and auto loan data.

History shows that it takes 22 months — on average — from the first US Fed rate hike to the onset of a US economic contraction. Economic growth is also always fastest during periods of rising rates. The fact that the US economy has not contracted yet does not mean a contraction is off the cards. The lag we’re currently experiencing between the Fed’s first hike and the start of a US contraction is still well within the normal range.

Accordingly, our base case remains one of slowing economic growth and probably recession in the next six to 12 months. Rising geopolitical risks increase the probability of this outcome. The portfolios are conservatively positioned and should do especially well should there be a US recession, with ample liquidity to buy long-term investments at discounted prices. If we are wrong — and there is no recession — then the portfolios should still do well in absolute terms.