Market Outlook November: Market volatility has come to the surface
Our portfolios are well diversified across sectors and regions. October clearly demonstrated the benefits of this approach. The global equity index ended the month down just under 2% in local currency terms. Beneath that headline figure, however, there were significant differences in performance across sectors.
AI-related sectors, including technology and communication services, fell sharply, while more defensive sectors such as healthcare and consumer staples performed correspondingly well. Energy was the strongest performer, rising by more than 10% as oil prices continued to climb.
Have Interest Rates Peaked?
Whether long-term interest rates have peaked is difficult to determine. We can expect some further rate increases from the major central banks, but these are unlikely to translate into significantly higher long-term rates. Much of this is already reflected in market prices.
The US Federal Reserve has made it clear that inflation remains above its target and has done so for some time. At the same time, interest rates are already at a high level and are likely restrictive. We also see no signs of accelerating wage growth in the US, traditionally an important driver of higher inflation.
The European Central Bank met at the end of October. Earlier this year, it had been clear that interest rates should rise if inflation increased, even when that increase was driven by higher energy prices. Its message is now more balanced, with greater emphasis on the risk that rising energy prices could weaken economic growth. If so, the need for further rate increases would be reduced.
Overall, we believe the potential for a further significant rise in interest rates is limited. Any additional tightening by central banks is likely to be moderate, while much of it is already priced into markets.
Another interesting feature of October was that interest rates fell when volatility increased in parts of the equity market. As a result, bond prices rose and bonds once again provided diversification when equities came under pressure. We believe this is partly because interest rates have reached levels where bonds can once again compete more effectively with equities. Inflation would ideally be lower to provide greater conviction in the outlook for bonds, but conditions are rarely perfect when making investment decisions.
Oil and Energy
An important source of uncertainty is the outlook for the oil market. If conditions in the Strait of Hormuz normalise, the market could move towards a period of excess capacity, creating downside risk for oil prices.
Several analyses also indicate that volumes of oil and refined products flowing through the Strait of Hormuz increased significantly in September and October, particularly for crude oil. Nevertheless, oil prices have remained relatively high this autumn. Geopolitical uncertainty surrounding Iran remains an important part of the risk picture.
Developments are inherently difficult to predict, but our base case remains that a more diplomatic path will ultimately prevail.
Global Equities
The third-quarter reporting season is now well under way. In the US, more than half of companies have reported their results. Earnings growth is on track to reach a solid 30%, although the picture is more mixed than previously. This is particularly evident among some of the so-called “Magnificent Seven” companies, which had a significant influence on market developments towards the end of October. Companies placing the greatest strain on free cash flow were hit hardest. One of the key challenges for investors is assessing current earnings against future depreciation associated with substantial investment programmes. At the same time, while investment plans continue to increase, these companies are still reporting clearly rising revenues from their cloud businesses.
The most important lesson from October was once again the value of diversification. Technology-heavy equities fell significantly, while defensive sectors such as healthcare and consumer staples rose by around 10%. The fact that October produced a sector rotation rather than a broad market sell-off also reflects macroeconomic conditions that remain supportive for equities. Preliminary figures indicate that the US economy grew by well over 3% in the third quarter.