Q2 2023
Global equities experienced positive growth in the quarter, led by developed markets, particularly the US, while emerging market stocks lagged behind. Technology stocks, driven by enthusiasm for artificial intelligence (AI), performed well. Major central banks raised interest rates during the period, although the US Federal Reserve decided to keep rates unchanged in June. Government bond yields increased, resulting in lower prices.
In the US, equities ended the quarter on a higher note, with the majority of gains occurring in June. The rise was supported by moderating inflation and indications of a resilient US economy despite higher interest rates. Revised GDP figures showed a 2% expansion (annualized) in the first quarter, surpassing the previous estimate of 1.3% growth.
The Federal Reserve raised interest rates by 25 basis points (bps) in May but opted for a "hawkish pause" in June, meaning no rate hike was implemented. The "dot plot" of rate predictions indicated expectations for two more rate increases in 2023.
US inflation, as measured by CPI, declined to 0.1% (month-on-month) in May, down from a 0.4% increase in April, primarily due to a decrease in energy costs. Annual inflation dropped to 4.0%, lower than the expected 4.1%. Overall, the US economy remained strong, although the unemployment rate increased to 3.7% in May from 3.4%. Despite the uptick, the labour market remained historically tight.
Concerns initially arose regarding the US debt ceiling, but Congress passed legislation in early June to suspend the debt ceiling, which had minimal impact on economic growth.
The information technology (IT) sector led the stock market's growth in the quarter, driven by semiconductor stocks. Positive sales projections from US chipmakers highlighted the growth potential associated with AI. Towards the end of the quarter, the Dutch government imposed restrictions on the export of high-end chip manufacturing machines, potentially reducing exports to China. Financials also performed well, particularly banks, as strong near-term earnings were anticipated.
In the eurozone, shares saw gains in Q2, with financials and IT leading the advance. Energy and communication services sectors underperformed.
The IT sector benefited from semiconductor stocks, as higher-than-expected sales projections from US chipmakers emphasized the potential of AI. However, the Dutch government's decision to restrict the export of chip manufacturing machines may impact exports to China. Among financials, banks outperformed due to expectations of strong near-term earnings.
The European Central Bank (ECB) raised interest rates twice during the quarter, bringing the main refinancing rate to 4.0%. Headline inflation declined, with an estimated annual inflation rate of 5.5% in June, down from 6.1% in May. Core inflation, excluding energy, food, alcohol, and tobacco prices, slightly increased to 5.4% in June.
Growth data indicated a mild recession in the eurozone during the winter, with GDP declining by -0.1% in both Q4 2022 and Q1 2023. Forward-looking indicators suggested a slowdown in eurozone economic momentum, as the flash composite purchasing managers' index (PMI) fell to 50.3 in June from 52.8 in May, indicating a potential stagnation.
UK equities experienced a decline during the quarter, with energy and basic materials groups being the primary detractors. Weakness in commodity prices and concerns over the Chinese economy affected these sectors. Strength in the sterling currency also impacted US dollar earners, including consumer staples.
Domestically focused areas of the market also underperformed as the Bank of England (BoE) raised rates twice, with a 0.5 percentage point increase in June. The rate hikes were driven by strong UK jobs market numbers, wage growth, and core inflation readings. The rise in rates led to a sell-off in UK gilts, resulting in rising yields. Housebuilders were particularly affected by the higher rates.
The Japanese market reached its highest level in 33 years, with the Nikkei reaching 33,700 yen in June. Foreign investor buying, continuous structural shifts in the Japanese macro economy, yen weakness, and strength in the US market all contributed to the market's positive performance. Despite reaching fair valuation levels, there is potential for upward earnings revisions in the coming months, supported by yen weakness.
The Bank of Japan (BoJ) maintained its dovish stance under new governor Kazuo Ueda, while the US Federal Reserve continued to raise interest rates, leading to yen weakness. Solid progress in macroeconomic figures contrasted with the BoJ's cautious stance on inflation and wage growth.
Asia ex Japan equities recorded a negative performance in the second quarter, with China, Malaysia, and Thailand being the worst-performing markets. India, South Korea, and Taiwan, on the other hand, experienced gains.
China's equities experienced a sharp decline in Q2 as the economic rebound following the COVID-19 crisis started to cool. Slower factory output, weak consumer spending, and reduced demand for exports due to interest rate increases in the US and Europe contributed to the decline. Hong Kong shares were also negatively impacted by the cooling Chinese economy.
India's equities performed well, driven by foreign inflows, steady earnings, and encouraging economic data. Taiwan's equities advanced due to gains in technology stocks related to AI. South Korea also experienced positive performance, supported by investor enthusiasm for AI-related stocks. The Philippines and Singapore ended the quarter with negative returns, while Indonesia saw modest gains.
Emerging market equities delivered a modest gain in the quarter, lagging behind developed markets. Tensions between the US and China and concerns about China's economic recovery were factors affecting emerging markets. The resolution of US debt ceiling uncertainty in early June helped improve the negative sentiment.
Hungary, Poland, and Greece were the top-performing markets despite rising recessionary fears in Europe. Central European markets anticipated rate cuts as inflation eased, with Hungary implementing rate cuts in June. Greece's outperformance was attributed to the ruling New Democracy party winning a second term in office, signalling market-friendly policies.
Brazil also performed well due to easing fiscal policy concerns, optimism about potential rate cuts, and better-than-expected Q1 GDP growth. Improved macroeconomic data and indications of ongoing accommodative monetary policy supported India's strong performance.
Colombia, the UAE, Peru, Saudi Arabia, and Mexico also posted gains, while Kuwait, Qatar, China, and South Africa lagged. Turkey experienced the largest loss in US dollar terms, coinciding with President Erdogan's re-election, extending his rule.
Market volatility decreased significantly during Q2, although government bond yields rose. The UK and Australia underperformed due to higher-than-expected inflation and central banks' determination to combat inflation. The Federal Reserve paused its rate increases after over a year of consecutive hikes. Corporate balance sheets remained relatively strong, despite a slight increase in default rates. Global high yield outperformed global investment grade, as immediate recessionary concerns were diminished.
In the US, investment grade bonds posted negative total returns but outperformed Treasuries in the quarter. US high yield bonds generated positive returns. The US 10-year yield rose from 3.47% to 3.81%, with the two-year yield increasing from 4.03% to 4.87%, further inverting the yield curve.
The ECB continued to raise interest rates and announced plans to end reinvestments under its Asset Purchase Programme from July 2023. Headline inflation declined significantly from its peak, while the core inflation rate slightly increased.
In the UK, inflation surprised many and prompted the Bank of England to take more decisive action, raising interest rates by 50 basis points in June. UK government bond yields jumped, with the 10-year yield increasing from 3.49% to 4.39% and the two-year yield rising from 3.44% to 5.26%. UK high yield bonds outperformed investment grade bonds.
Currency performance saw lower-yielding currencies, such as the Japanese yen, performing poorly, while the British pound was the top performer due to higher interest rates.
In the digital assets space, Bitcoin returned 6.9% in Q2, outperforming Ethereum (ETH) which recorded a 6.0% gain. Regulatory developments continued to shape the digital assets landscape, with the European Union adopting MiCA, a regulatory framework for digital assets. In the US, different institutions pursued various approaches to regulate cryptocurrencies. SEC action against Coinbase impacted altcoin liquidity. Expectations for Bitcoin ETF approvals and ongoing SEC lawsuits contributed to Bitcoin's outperformance over altcoins.
The S&P GSCI Index had a negative performance in Q2, with industrial metals and energy sectors being the worst performers. Livestock prices increased, while cocoa and soybean prices rose sharply, offsetting declines in coffee, sugar, and corn. Precious metals, gold, and silver ended the quarter in negative territory.
Overall, Q2 2023 saw positive growth in global equities, though with some variations across regions and sectors. Central banks raised interest rates, government bond yields increased, and there were developments in the regulatory environment for digital assets.
