Monthly markets review - February 2023

The month in summary:

Global equities declined in February in US dollar terms after the strong advance seen in January. Resilient economic data suggested that any hoped-for pause in interest rate rises may still be some way off. The Federal Reserve, European Central Bank and Bank of England all raised rates in the month. In fixed income, government bond yields were higher (meaning prices fell).

Please note any past performance mentioned is not a guide to future performance and may not be repeated. The sectors, securities, regions and countries shown are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

US

US equities declined. The Federal Reserve (Fed) indicated that policy intervention was starting to work on curbing inflation, but that the policy rate may peak at a higher point. Economic data otherwise remains strong.

Fed Chair Jerome Powell reaffirmed that a slowdown in inflation is underway and that its 2% target is achievable. The Federal Open Market Committee (FOMC) minutes from the 1 February meeting showed that while almost all members agreed to slow the pace of rate hikes to 25 basis points, there was a general consensus that rates may need to rise further than was initially assumed to bring inflation under control.

Inflation, as measured by the headline consumer price index (CPI), climbed 0.5% in January after a 0.1% increase in December; the pick-up was driven by the energy component. Q4 GDP growth was revised down in the second reading, to a still-strong 2.7% (quarter-on-quarter, annualised).

Almost all sectors of the S&P 500 were weaker. Technology was comparatively resilient. Chipmaker Nvidia was a notable performer having posted strong results and announced greater involvement in artificial intelligence. Energy was amongst the weakest sectors with investors eyeing potential cost pressures.

Eurozone

Eurozone shares gained in February. Top performing sectors included communication services, financials, industrials and consumer staples. Real estate, IT and healthcare posted negative returns.

Forward-looking data painted an encouraging picture for the eurozone economy. The flash Markit composite purchasing managers’ index for February reached 52.3, up from 50.3 in January, indicating the strongest expansion of business activity since last May. (The PMI indices are based on survey data from companies in the manufacturing and services sectors. A reading below 50 indicates contraction, while above 50 signals expansion.)

The European Central Bank (ECB) raised interest rates by a further 50 basis points (bps), taking the main refinancing rate to 3.0%. A further increase is expected in March. Markets had interpreted signs of easing inflation in January as meaning that the pace of hikes could soon moderate. However, preliminary data for February indicated that inflation ticked up again in both France and Spain, casting doubt on hopes of an end to rate rises.

February saw the European Commission propose a Green Deal Industrial Plan. This aims to provide support for scaling up the EU's manufacturing capacity for the net-zero technologies and products that will be needed to meet Europe's climate targets.

UK

UK equities held up well during the month. Large cap companies were among the top contributors and the FTSE 100 index achieved a new record high. The market was led by the energy, healthcare and telecoms sectors. These sectors benefited from a period of renewed dollar strength as investors questioned whether US interest rates might have to rise further than expected.

A number of domestically focused areas of the market also outperformed as it transpired that the UK economy has been performing more resiliently than expected. Notably, the latest GDP data from the Office for National Statistics revealed that the UK economy had not contracted in Q4 2022. As a result, the economy dodged a technical recession by avoiding two consecutive quarters of decline following the contraction in Q3 2022.

In its latest quarterly forecast for the UK, the Bank of England said it still expected the country to fall into a recession later in 2023. However, it said the downturn would be shallower than it had predicted at its previous forecast made in November, since which time wholesale energy prices have fallen considerably. The Bank raised the UK base rate by half a percentage point at the latest Monetary Policy Committee meeting. The accompanying comments following the meeting suggested the Bank thought the rate had hit its peak for this cycle.

Japan

The Japanese stock market rose slightly in February. The total return was 0.9% in local terms. The yen weakened sharply after testimony to the Diet by Kazuo Ueda, the nominee to be the new Bank of Japan (BoJ) Governor, as he appeared to prefer the status quo on monetary policy. Yen weakness supported market sentiment, especially for exporters.

Prime Minister Kishida’s decision to nominate Kazuo Ueda, an economics professor and former policy board member of the BoJ, surprised the market. Consensus had been that the role would go to Masayoshi Amamiya, the current deputy governor, who reportedly declined it.

Inbound tourism has been sharply recovering. The number of foreign visitors in January was back to 60% of the pre-Covid period. Strong demand boosted sales of retailers, hotels and services, which was demonstrated in the Q4 earnings results for domestic companies.

Inflation in Japan has been steadily picking up and CPI was recorded at 4.3%, the highest level in the last 40 years. To cope with this historically high inflation environment, the Japanese government and BoJ are pushing companies to raise wages at the annual wage negotiations in March.

Quarterly earnings results announced from late January to mid February were mixed. Exporters had a difficult time due to yen appreciation during Q4 2022, and a slowdown in production affecting the technology sector. Domestically-oriented companies recorded better-than-expected sales numbers but suffered from cost increases, including the electricity price hike.

Asia (ex Japan)

Asia ex Japan equities recorded a negative performance in February, driven lower by sharp declines in China and Hong Kong. This was a partial reversal of the strong gains seen in prior months and was partly due to escalating geopolitical tensions. All index markets ended the month in negative territory, with the smallest fall recorded in Indonesia. Thailand, Malaysia and South Korea experienced sharp falls as investors took profits following a strong performance in January on investor optimism sparked by China’s reopening.

Indian equities were also weaker in February, with domestic inflation numbers and global issues, such as the ongoing war in Ukraine, adding to investor worries over growth. Concerns over interest rates amid a global economic slowdown also weakened investor sentiment towards the country in February. Share prices in Singapore, Taiwan and the Philippines also ended the month in negative territory, although the declines were more modest.

Emerging markets

Emerging market (EM) equities posted negative returns in February and underperformed global equities. A re-escalation in US-China tensions weighed on sentiment while more resilient-than-expected macro data out of the US raised the prospect of further rate hikes. Against this backdrop the dollar strengthened, which was an additional headwind for EM.

Colombia was the weakest index market amid widespread protests against the government’s reforms. China also lagged the index by some margin. In part this was due to profit-taking after strong returns recently and as enthusiasm about its re-opening faded somewhat. The underperformance was also driven by geopolitical tensions between itself and the US following the shooting down of a Chinese high-altitude balloon in US airspace. Thailand and Brazil both underperformed too. The former saw Q4 GDP growth come in lower than expected while exports contracted given weak global demand. In Brazil, uncertainty about China’s recovery weighed on returns.

South Africa was behind the index too as the country was ‘grey-listed’ by the Financial Action Task Force given deficiencies in its processes to combat money laundering and terrorist financing. Saudi Arabia fell, led lower by the banking sector. Korea posted negative returns that were worse than the index as the combination of the prospect of ‘higher-for-longer’ rates and uncertainty about China’s recovery weighed on the outlook for global trade.

India outperformed, despite Q4 GDP data that came in below consensus. Poland came in ahead of the index as did Chile and Peru. Qatar and Kuwait posted negative returns, against a backdrop of weaker energy prices, but performance was better than the index.

The UAE delivered positive returns as the banking sector recovered from its sell-off in January. Turkey and Egypt were strong with the former helped by currency weakness. The market outperformed despite the deadly earthquake that hit the country early in the month.

Global bonds

Global government yields were higher in February. Risk assets performed poorly – US credit (both high yield and investment grade) spreads widened as markets anticipated higher rates for longer. The US underperformed while European credit fared better. (Investment grade bonds are the highest quality bonds as determined by a credit rating agency; high yield bonds are more speculative, with a credit rating below investment grade.)

The Fed hiked rates by 25bps at the beginning of the month, but following strong data, markets concluded that interest rates would likely need to remain higher for longer. Activity data rebounded during February – US payrolls were higher than expected and survey data rebounded from prior weakness. Some of this is likely due to challenging seasonal adjustments and distortions due to weather. Services PMIs for February rebounded; while the manufacturing PMI did improve, the broad trend is still weak.

The ECB hiked rates by 50bps early in the month and signalled an additional 50bps at their next meeting in March. The message was construed as dovish, given acknowledgement of the improving inflation profile from energy prices.

European data (PMIs) followed in the footsteps of other economies, such as the US, with improving services but limited signs of improvement from the manufacturing sector. However, figures still reflect much more positive momentum than seen only a few months ago, with February’s composite number rising further into expansionary territory. Recessionary risks appear to have been priced out of the market.

In Japan, Kazuo Ueda was nominated as Bank of Japan governor. Markets are trying to work out what this means for monetary policy-particularly yield curve control.

The US 10-year yields rose from 3.51% to 3.92%, with the two-year rising from 4.21% to 4.82%. Germany’s 10-year yield increased from 2.29% to 2.65%. The UK 10-year yield rose from 3.34% to 3.71% and 2-year increased from 3.46% to 4.07%.

The US dollar was stronger against most G-10 peers. The Swedish krona was the outlier, strengthening on higher-than-expected inflation and the anticipation of a hawkish response by the Riksbank.

Convertible bonds protected well against losses from the equity market. The Refinitiv Global Focus shed less than 2% in US dollar terms. February turned out to be a good month for primary market activity. We saw US$10.2 billion of new paper coming to the market. The US remained the dominant region, followed by European convertibles.

Commodities

The S&P GSCI Index recorded a negative performance in February. Industrial metals and precious metals were the worst-performing components of the index. Within industrial metals, nickel, zinc and aluminium all experienced sharp price falls, while declines for lead and copper were more muted. Within precious metals, silver and gold prices both declined in the month. Energy prices were also weaker. Within agriculture, wheat, Kansas Wheat and corn all experienced significant price falls.

Digital assets

After one of the best monthly performances recorded in January, digital asset markets paused for breath in February. The performance of Bitcoin and Ethereum was relatively flat, returning 0% and 1.3% respectively. Total crypto market cap stands today at nearly US$1 trillion, up from US$756 billion at the beginning of the year. The month saw an increase in regulatory activity with the SEC investigating a number of notable firms as well as the UK regulator kicking off an ambitious digital asset regulatory review.

User activity remained healthy as a recent report published by crypto.com revealed that crypto holders increased by 39% in 2022 from 306 million to 425 million despite the bear market. Looking ahead there is an important Ethereum network upgrade called the Shanghai fork which opens up withdrawals of staked ETH tokens, a last step in the network’s shift to proof-of-stake.

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.