Markets generally started the third quarter in a strong position, as the consumption-led recovery continued and inflation started to show signs of slowing. But the latter half of the quarter was dominated by a massive bond sell-off. Yields on US Treasuries and long-dated government debt around the world rose to multi-year highs.
The sell-off came as core inflation failed to fall in line with headline inflation. Core inflation has been driven by wage growth and tight labour markets, keeping upward pressure on inflation. Furthermore, commodity prices had shown signs of bottoming out at the start of the quarter, but started to rise later in Q3. Oil prices, which had been trading at around $70-80 per barrel, rose to more than $90, fuelling concerns over a resurgence in headline inflation. As such, the timeline for rate cuts was extended, with central banks showing few signs of lowering interest rates imminently.
Against an unhelpful higher yield backdrop, equities have experienced weak performance, with the US market suffering its worst month of the year so far in September. Other major indices in Europe and Japan were also negative. Higher oil prices were good for the UK, with the region up during the third quarter.
During Q3, the fund delivered a modestly positive return and outperformed the benchmark.
Some bond holdings declined following the sell-off in bond markets. On an absolute performance basis, government bond holdings were among the worst affected, including our exposure to inflation-linked UK gilts. There was mixed performance from our corporate bond holdings, with UK debt holding up better than our international holdings.
The fund’s cash holdings were a positive contributor to performance as interest rates remained at elevated levels.
Our equity exposure, which represents around a quarter of the strategy, was positive during the quarter, principally driven by gains in our allocations to Japan, the US and the UK.
The fund’s property exposure detracted from performance during the quarter. The UK property market declined during the period, and investor sentiment remains weak.
While central banks are unlikely to raise interest rates as quickly as before, more upward pressure on inflation, particularly with oil prices so high in Q3, means higher interest rates could be here for some time. These higher rates have taken longer to feed through to consumers, with both the labour market and consumption remaining strong. But we believe that rate hikes will eventually result in slower growth.
Corporate spreads may start to come under some pressure in the coming quarters as companies struggle to pass on higher costs to the consumer and demand for goods and services slows down. We have already started to see signs that consumer demand is falling in the US, amid reduced credit availability and exhausted pandemic-era savings.
For now, we believe that equity markets remain at the mercy of bond markets as, higher yields offer more attractive and less risky investment opportunities.
Although central banks remain confident that their economies will achieve a soft landing as inflation moves back to target levels within the coming years, it seems likely that the probability of success is declining. And heading towards 2024, economic growth is likely to moderate somewhat after the post-Covid bounce we have seen over the past two years.
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
The WS Canlife Portfolio Funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the funds. The value of the property is based on the opinion of a valuer and is therefore subjective.
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Promotion approved 23/10/23