April 2023 MPS Market Review

• The broad market recovery continued in April as risks of systemic bank failure further receded from investors’ minds.
• After a relentless march higher over the prior 12 months, the prospective end to US interest rate hikes also likely buoyed sentiment.
• Heightened inflationary pressures in the UK and Europe will delay the end to their respective tightening cycles, however, the peak in interest rates is coming into view.
• Whilst the benign market reaction to the prospect of more accommodative interest rate policy is coherent, the more complete narrative highlights the risks which prevail.
• The significant catalyst behind falling interest rate expectations has been the anticipation of more restrictive behaviour from commercial banks.
• Such entities are likely to behave more cautiously in the face of increased costs, as depositors demand better rates to remain customers, and as regulators increase levies to cover heightened regulation.
• Rising bank costs, however, will further increase bank sensitivity to loan losses and, therefore, will likely impinge on the level of bank lending, particularly into the more speculative areas of the economy.
• Reduced lending would act as a brake on both growth and inflation expectations; a combination which has compelled investors to anticipate lower levels of interest rates.
• Bond markets are now priced for several US interest cuts over the coming 12 months.
• All else equal, lower levels of interest rates are good news for share prices as they increase the present value of future cash flows.
• Should banks withdraw particularly aggressively from lending activity, however, then the prospect of a more damaging downturn would increase.
• In such circumstances the positive impact of falling interest rates might be dwarfed by the prospect of surging unemployment, collapsing revenues and tumbling profits.
• Investors should not, therefore, consider falling interest rates as a ubiquitously positive backdrop. There should be conditionality, as it relates to extreme events, attached.
• In the face of more persistent inflationary pressure, investors should also be alert to the risks of a ‘higher for longer’ interest rate environment; particularly if central banks are less fearful of bank failures.
• A more restrictive monetary policy raises the prospect of more troubling economic outcomes later in the year, or early in 2024, and might become an increasing headwind to markets.
• Investors should brace themselves for further volatility on this basis, but we would again argue all may not be lost for equity investors in such an environment.
• A recession that seems so widely predicted may not inflict the same damage as one that catches investors off-guard.
• The recession may not be so severe either, given the apparent absence of major economic imbalances i.e. corporations and households don’t (in aggregate) appear to be shouldering quite so much leverage as in prior, more devastating recessions.
• We should also remind ourselves that having moved off the zero bound, there are now interest rates to cut! Again, this policy flexibility might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm.
• Timing a defensive pivot to then time the recovery is also a risky game, and one this MPS is reluctant to play; preferring instead to take a more measured approach which incorporates longer term thinking.
• We would also highlight the conditions driving a ‘higher for longer’ interest rate environment might be more constructive for market performance than widely communicated.
• ‘Higher for longer’ policy is still an end to further tightening and, if accompanied by low (but still positive) growth and falling (if above target) inflation, could still be a rewarding mix for investors.
• Recognising the outlook remains uncertain, however, as well as our philosophical belief in the need for humility when investing, MPS portfolios strive to seek appropriate levels of diversification to meet the investment challenges ahead.
• Relative to stocks for example, high quality corporate and government bonds might offer a more defensive return profile in the face of less encouraging growth outcomes, particularly given the increase in yields observed over the past 12 months.
• Alternative asset classes also assist Invesco in its efforts to help diversify portfolios in a more troubling period for stock markets.
• Stay safe, stay well, and please get in touch if you wish to discuss any part of the Invesco MPS strategy further.

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