2023 mid-year review: market resilience has surprised the bears

While 2023 has given investors plenty of reasons to worry, the gloomy scenario envisaged by many economists at the start of the year has not come to pass. The much-anticipated US recession has been deferred, while financial markets have remained resilient.

The IMF is now predicting a rise in global growth of 2.8% for 2023.¹ Nevertheless, there is a sharp divide between emerging and developed economies, with the latter showing GDP growth forecasts of just 1.3%, while emerging markets economies are expected to expand 3.9%, led by over 5% growth in China and India.¹

Stronger economic growth across many regions has brought a distinct set of problems: inflation has come down but has proved far stickier than many expected, with labour markets remaining healthy across most major economies. This has forced central bankers to continue raising interest rates. While the US Federal Reserve (Fed) appears to have paused with central bank rates of 5.25%, the UK and eurozone central banks are still raising rates and have indicated further rises may lie ahead.

Financial markets have been resilient. The disruption created by the collapse of several banks proved short-lived, with swift action from policymakers and regulators preventing wider contagion.

Companies showed themselves adept at passing on higher costs to their customers, which shored up their earnings. There remain concerns that this pricing power could ebb as higher borrowing costs squeeze consumers and businesses, but there are few signs of it yet. We explore this in more detail in our article: power to the corporates.

US

The US stock market saw a surprising surge from the technology sector. After a grim year in 2022, technology companies faced significant headwinds from rising interest rates and weaker earnings in 2023. However, against expectations, they roared back in 2023. The Nasdaq is up 28.6% for the year to date², compared to 13.2% for the S&P 500³ and just 1.8% for the industrials-heavy Dow Jones. The galvanising force has been generative artificial intelligence, with excitement around Chat GPT creating interest in semiconductor companies such as Nvidia as businesses look to invest in this new technology. We take a deeper dive into this area with our pieces: breaking down the enigma of artificial intelligence, and our megatrends piece: how will AI impact your future investments?

The US economy continues to deliver mixed messages. A buoyant labour market has continued to reduce expectations of a deep recession. Availability of loans had fallen, even before the problems in the banking sector, so this is acting to cool the economy. The Fed has remained resolute on interest rates. Although it paused rate rises in June, it has made it clear that it is willing to raise them again should inflation continue to rise.

UK

Recession appeared an inevitability for the UK economy at the start of the year. As it is, it has not materialised, with falling energy prices, government support and a resilient consumer all acting to shore up growth. The labour market has also remained strong, with private sector wage growth hitting 6.9% in the first quarter of the year⁴.

The downside has been felt in inflation figures, which have remained stubbornly high. CPI inflation finally fell below 10% in May⁵ but has been persistently higher than expectations. The Bank of England has been forced to keep raising interest rates, which are now expected to peak at around 6%.

The UK stock market had a weak start to the year as commodity prices fell and the banking sector was hit by the failures of Credit Suisse in Europe and Silicon Valley Bank in the US. The resurgence of US technology stocks also impacted the UK market as investors swapped value for growth companies. The main UK index, which has a bias toward energy and mining stocks, was also hit by a combination of lower energy and commodity prices. The strength of sterling, which rose in response to higher interest rate expectations, also impacted the performance of the UK stock market.

Europe

It was a stronger period for stock markets in Europe as company earnings improved and outstripped the US early in the year. A mild winter and prompt action by governments across the region saw an energy crisis averted. The region was also lifted by the resurgence of China, which is an important export market, particularly for Germany and Spain. The Euro Stoxx index rose 12.8%⁶. This led us to ask if we are seeing a European renaissance?

The European Central Bank raised interest rates to 3.5% in June, their highest level in 22 years. Eurozone Consumer price inflation sat at 6.1% for the year to May⁷, having declined steadily from over 10% in October. The Central Bank expects inflation to fall further, but a rise in core inflation in June driven by wage rises makes further rate rises more likely.

Asia

The outlook for Asia has been dominated by China. The country’s reopening in October 2022 led hopes of galvanising global economic growth at the start of the year. However, the initial stock market rally petered out as growth has not bounced with the vigour many had hoped. Consumption has been weaker than expected and confidence has not returned to pre-pandemic levels⁸.

This has had a knock-on effect on the wider region. Asian markets have continued to lag their global counterparts⁹ as expectations of a swift return to economic growth in China have receded.

Nevertheless, there remain plenty of reasons to be optimistic. Chinese stimulus was directed towards infrastructure projects and business investment. This is beginning to feed through to the economy and is being translated into company profits. With greater policy stability, higher growth and stronger earnings all seem likely in the near term.

Japan

Japan has been rediscovered by investors in 2023, with veteran investor Warren Buffet making a high-profile investment in the country’s stock markets¹⁰. The catalyst has renewed faith in improvements in corporate governance for many Japanese companies. The Tokyo Stock Exchange has taken steps to improve companies’ return on equity, which is starting to be seen in Japanese companies using their cash more productively.

The Japanese economy is also starting to improve as reopening gathers pace and wage growth drives consumer spending. As a net importer, it is also benefiting from lower oil prices, which is helping to improve the Government’s fiscal position. In March, we asked whether Japan’s recent market struggles are behind us?

Gold

The strong US dollar has been a feature of financial markets in 2022, benefiting from its ‘safe haven’ status in an uncertain environment. However, this started to fade from August onwards; see our article down with the dollar as the rest of the world caught up on interest rates. This has helped the gold price, which saw a significant rally from November to May. Central bank demand has also been a factor in shoring up the gold price as geopolitical tensions between the East and West have seen some governments favour gold over the US dollar to store their reserves. To find out more, read our article: a golden message for financial markets.

However, more recently, gold has started to wobble. Investors now believe that more Fed interest rate hikes may be necessary to curb inflation. Higher interest rates tend to push the gold price lower because gold pays no income.

Bonds

The yield on US ten-year government bonds dipped as low as 3.3% in April, but by the middle of the year, it moved back up to 3.7% as investors started to anticipate more rate rises ahead. The yield on two-year bonds have been as high as 5% and as low as 3.7% since the start of the year, reflecting the significant uncertainty over short-term interest rate movements.

Short-dated bonds are now trading with higher yields than longer-dated bonds. This situation is known as an inverted yield curve and means investors expect the Fed will cut rates over the longer term. This inversion is currently commonplace, with 37 countries now trading with inverted yield curves, including the UK, Germany, France and Canada¹¹.

Spreads, the difference in yield between corporate bonds and similar government debt, bonds have narrowed despite higher interest rates and talks of a recession. They are now around half the level they were at the peak of the Global Financial Crisis and the Covid pandemic. There are several factors behind this: many companies refinanced their debt during the Covid pandemic as borrowing costs were cheap, so there is no immediate financing risk. Businesses have also been able to pass on higher prices to their customers resulting in record profit margins and a strong labour market continues to support the economy.

To refresh your knowledge on fixed income, you can read our recent piece: the basics of bonds.

Financial markets seem to be in a holding pattern, waiting to see how much impact higher interest rates will have on economic activity and looking for clear signs that the interest rate cycle has peaked, and the next rate move is downwards. From the strength of China’s recovery to a potential recession in the US to the resilience of the corporate sector, there are major questions going into the second half of this year.

Please note: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data above. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This article is not approved, endorsed or reviewed by MSCI.

Sources:

¹A Rocky Recovery, World Economic Outlook, International Monetary Fund, April 2023

²NASDAQ Composite Index, Marketwatch.com [accessed 30 June 2023]

³S&P 500 Index, Marketwatch.com [accessed 30 June 2023]

⁴Average weekly earnings in Great Britain: May 2023, Office for National Statistics, 16 May 2023

⁵Smith, G., Finally — UK inflation falls below 10 per cent, but the stickiness is too obvious to ignore, Politico, 24 May 2023

⁶Euro Stoxx 50 Index, Marketwatch.com [accessed 30 June 2023]

⁷Euro Area Inflation Rate, Tradingeconomics.com [accessed 30 June 2023]

⁸Zipser, D., China Brief: The Return of the Chinese Consumer?, McKinsey & Company, 28 April 2023

⁹MSCI AC Asia Index (USD), Index Factsheet, MSCI, 31 May 2023

¹⁰Hornyak, T., What Warren Buffett is buying in Japan’s Berkshire Hathaway look-alikes, CNBC, 5 May 2023

¹¹Inverted Yield Curves, worldgovernemtnbonds.com [accessed 30 June 2023]