MARKETS IN A NUTSHELL - MARCH 2023

“Beware the ides of March,” said the soothsayer in Shakespeare’s Julius Caesar. Caesar would have done well to heed this warning: he was assassinated soon after in mid-March of 44 BCE. The ides of March 2023 deserved its own omen as the “no-landing” sentiment prevailing at the end of February gave way to no less than three US bank failures and the emergency rescue of Swiss banking icon, Credit Suisse.

The result was dramatic bond market volatility as investors speculated on the future path of interest rates. Bond volatility spiked to its highest level in over a decade, surpassing even the peaks of the COVID-19 crisis in 2020. Curiously, the VIX — which measures stock market volatility — remained disconcertingly low. However, more astute investors may recall that it was at similar levels before spiking dramatically during the 2008/2009 Financial Crisis.

Ironically, it was exposure to “low risk” long-dated government bonds that precipitated the collapse of Silicon Valley Bank. Rapidly rising interest rates and the savings rotation from bank deposits to higher yielding money market funds exposed pockets of fragility in the banking system. This precipitated a seismic shift in Treasury yields, with the 2-year yield dropping the most since “Black Monday” in October 1987.

But timely February data confirmed that US inflation remains uncomfortably high. The Fed raised rates by another 25 basis points, taking the federal funds target rate to 5.0%. Policy rates were also increased in many other regions including the UK, Europe and in emerging markets such as South Africa, where positive interest rate differentials helped to stave off local currency weakness.

Remarkably, the net result of the March turmoil was slightly positive returns for most developed markets. Bond prices rallied and equity valuations moved upwards on expectations that the next move in interest rates would be lower. Across the globe, news that technology giant Alibaba plans to break into six parts to unlock shareholder value boosted Chinese and Asian stock markets.

Against this tumultuous backdrop, the Foord global funds again delivered returns ahead of benchmark. The outperformance was a combination of judiciously low exposure to areas that came under pressure — such as US and European banks — along with good exposure to safe havens such as gold, and selective exposure to attractive equity opportunities including Alibaba. The Foord Asia ex-Japan Fund continues to show its stripes.

Looking ahead, investment prospects depend largely on the path of global rates, especially US rates. These depend in turn on the resilience of US inflation. When we assess the likely trajectory for US inflation, there are three key components to consider: commodities, rental prices and wages. Most commodity prices have eased from their peaks owing to a mild European winter and the easing of supply chain disruptions. The recent surprise decision by OPEC+ to slash oil output is nevertheless a headwind to this component.

The other components are stickier and more costly to contain. A shortage of housing stock and an affordability crisis in America for first-time homeowners have pushed up rental prices. Then, with 1.7 jobs available for every job seeker, it’s unlikely the upward pressure on wages will subside soon. These components are running at approximately 5% per annum. Given the upside risks to energy prices, in our view it is unlikely that US inflation that will retreat to the Fed’s 2% target without significant demand destruction.

We therefore continue to favour businesses that can withstand or even benefit from an inflationary environment. As forward-thinking investors, we continue to use our top-down process to allocate capital away from areas of risk and towards areas of opportunity, and our bottom-up stock-picking process to favour businesses with resilient business models and secular growth prospects.