Growing concerns about persistent high-interest rates impacted stocks and bonds as the third quarter closed. However, the fall of sterling against the US dollar shielded UK investors from these downturns, as both stocks and bonds in domestic benchmarks surpassed their global counterparts. In terms of sterling, the MSCI All Country World Index concluded the quarter with a marginal rise, whereas gilt indices recorded a drop, ending -0.8%.
The broader market outlook shifted notably after the September Federal Reserve (Fed) policy assembly. The US interest rate determinants adjusted their future interest rate predictions due to unexpected economic robustness. Even though they've hinted at higher rates than market anticipations for a while, this new communication led investors, who previously anticipated a lesser rate trajectory, to reevaluate their positions. Following this, the US 10-year Treasury yield surpassed 4.5%, a figure not seen since 2007.
Concurrently, the Bank of England (BoE) and the European Central Bank (ECB) signaled that their rate-increasing cycles might be nearing their culmination. The recent performance of UK and Eurozone economies hasn't matched that of the US. This, coupled with other indications, suggests that monetary policymakers believe they've possibly done enough, despite persistent inflation surpassing set targets.
In a significant move, the BoE barely opted to maintain the current policy, halting a streak of 14 straight interest rate hikes. The narrow 5-4 decision to keep the base rate at 5.25%, while close, was backed by influential members like Andrew Bailey, Ben Broadhurst, Sir Dave Ramsden, and Huw Pill. A surprising dip in the Consumer Price Index (CPI) to 6.7% the day prior, marking a third sequential drop and being notably less than the projected figures and last year’s high of 11.1%, undoubtedly influenced this decision.
UK equities had a successful quarter with a return of 2.5%, bolstered by the BoE's latest decisions and sterling's dip to 1.22 versus the US dollar, marking a 4% decline. Even though UK government bonds slipped over the quarter, they outdid their European and US counterparts. This was thanks to optimistic inflation news and the BoE revising its monetary policy outlook.
Wall Street encountered declines as the quarter wrapped up, with US yields hitting notable highs, finishing about 3.5% down in local currency. Nevertheless, annual returns in the US (13.1%) still surpass global indices (10.5%), the UK (+5.2%), and Europe excluding the UK (9.2%).
A fascinating trend emerged between growth and value stocks: the former prospered in the US, while the latter shone in Europe. The buzz around Artificial Intelligence (AI) has undoubtedly lifted several US tech stocks. However, the ascendency of growth stocks can be partially attributed to the economic vigor. Elevated interest rates usually impact growth stocks negatively due to higher future earnings discount rates.
Yet, the reason behind rising rates is crucial. If a booming economy triggers the hike, companies projected for more growth might benefit, potentially counteracting the downsides of a raised discount rate. This scenario appears to be unfolding in the US in 2023. The superiority of value stocks in Europe also aligns with this perspective, as gloomier economic outlooks impact growth stocks more than their value-based counterparts.