Q1 2023 Recap and Market Outlook
- The U.S. and other Developed Markets once again led equity market performance, strongly outperforming emerging markets in the first three months of the year.
- We remain optimistic about the global economic outlook for the second half of the year, especially if acute supply chain issues, that have hampered the post-pandemic recovery significantly, can be resolved.
- Despite that outlook, short-term volatility should be expected as investors come to grips with a new-normal risk-free rate and the reduction in easy liquidity.
- Long-duration bonds outperformed short-term securities as concerns around the banking sector increased the bid on long term safe-haven assets. Junk-rated securities, however, once again outperformed investment grade bonds on a duration adjusted basis.
- Based on the above factors, we are maintaining our portfolio positioning, with overweight positions in U.S. equities, non-investment grade rated bonds, and short duration. We are also maintaining relative underweights in emerging market assets and long-term bonds.
- This orientation will shift through the second half of the year as underlying economic conditions improve, and central banks around the globe pause their rate-hike cycle.
- Our most notable recommendation for clients would be to add fixed income to their investment portfolios as it could outperform equities in the near to medium term, not just on an absolute basis, but particularly on a risk-adjusted basis.
The first quarter has come and gone, but not without leaving an indelible mark on markets. Rising interest rates, low liquidity and a tighter lending environment weighed on economic growth in the U.S. Rallies fuelled by hopes for a Fed policy pivot were quickly cut short by hotter than expected inflation readings. Additionally, the banking system crisis towards quarter-end served to double down on the uncertainty weighing on investor sentiment. Despite all the upheaval, the S&P 500 ended the first quarter with a total return of 7.5%.
Although overall inflation has peaked, core inflation remained sticky, led by persistently high shelter costs. However, the labour market softened slightly, the unemployment rate moved from 3.4% to 3.6% and wage growth was markedly below year-over-year inflation readings. While some leading indicators of the labour market have started to decline, the Fed would need to see persistent weakness to effectively ease off the aggressive hike stance. This would also mean that the unemployment rate still has much further to go, possibly rising as high as 4.6% before the Fed feels comfortable with its price stability mandate.
The big news of the quarter was the stress in the banking sector with four major banks in turmoil, as depositors rushed to pull funds before regulators intervened, resulting in fears and echoes of the 2008 global financial system. Due to climbing rates, Silicon Valley Bank realized major losses from the sale of government securities to fund the exodus of fleeing depositors, which consequently incited a ripple effect for other banks. Though the storm has calmed for now, the unintended fallout makes it apparent that taming inflation may not just beget a recession but also shake financial stability. It is important to note, however, that the current crisis is very substantially different from the 2008 financial collapse, in cause, size, and scope.
Further impacts stemming from inflation concerns and rate increases were seen in the Energy sector as OPEC+ announced plans to cut production by 1.66 million barrels of crude per day on the fears of slowing demand, pushing Brent prices past $85 per barrel. Oil markets were already poised for a tight supply picture as China’s reopening could boost demand substantially in the latter part of the year, leaving many surprised by the decision to cut production.
Looking at other developed markets and particularly the Eurozone, which avoided a seemingly inevitable recession into Q1 2023 amid the war in Ukraine, the benchmark price of natural gas declined to €45/MWh, the lowest since late summer 2021. The European Central Bank (ECB) has taken up a restrictive stance as inflation surged to record highs last year, curbing growth prospects in the medium term. Still, European stocks rallied on a year-to-date basis after a dismal 2022, with Spain, France and Germany doing particularly well.
Meanwhile, in Asia, China’s economy is set for a rebound as exports pick up amidst the recent reopening. GDP growth forecasts improved for this year to 5.5% upon news of China’s softening its stance on property development. Pent-up consumer demand and excess household savings through the pandemic period could also add to strong economic performance of the world’s second largest economy. Other Emerging Markets, such as India, Taiwan, and Turkey, which import a large portion of their oil and gas needs, could be hit by a stronger dollar and weaker current account balances.
Notwithstanding the Fed indicating there will be no interest rate cuts this year, risk assets continued to surprise to the upside. We may continue to see banking woe consequences unraveling accompanied by the oil shock impact, leading to a reversal in risk appetite in the short term. Oil price volatility could persist but eventually smooth over the longer term. Recession risks loom and we expect a mild recession within the upcoming 12-18 months. Due to these factors, we are strongly recommending that investors add capital to their portfolios in the form of bonds.
Earnings may underwhelm in the U.S., as markets continue to digest the costs of economic slowdowns. Forward P/E on equities show stocks, though retreated from 2021 highs, are still relatively expensive but not too far from the historical norms. Companies that can maintain earnings growth with solid balance sheets and positive free cash flows alongside dividend paying and non-cyclical companies could be responsible for the majority of stock market returns in the near term. High yielding investment grade bonds should also outperform given the improving credit cycle for energy and materials sectors, while shorter duration government bonds shine a light of hope for safety while navigating an edgy market.
Local equities closed out the quarter ended 31st March 2023 with all 3 indices in the red. The Trinidad and Tobago Composite Index (TTCI) contracted by 1.49%. First Caribbean International Bank Limited (FCI) was the top gainer with its price appreciating 31.6%, as the bank’s financial performance improved in Q1 2023, buoyed by higher US interest rates. Prestige Holdings Limited (PHL) added 17.8% influenced by increased business activity post COVID-19 lockdowns, whilst AGL gained 17.1%.
Guardian Media Limited (GML) recorded the steepest decline of 25.2% followed by NCB Financial Group Limited (NCBFG) which contracted 22.1%. A one-off actuarial adjustment that occurred in NCBFG’s Life Health and Pension segment, among others, weighed on the group’s performance.
Additionally, the All Trinidad and Tobago Composite Index (ALL T&T) depreciated 1.65% whilst the Cross Listed Index (CLX) shed a marginal 0.90% after declining by 29.9% in FY2022. Massy Holdings Limited (MASSY) was the volume leader with 17.6M shares being traded followed by National Enterprises Limited (NEL) and JMMB Group Limited (JMMBGL) with 6.8M and 2.5M shares being traded, respectively.
Despite slight improvement to inflation from December to January, influenced by the easing in prices for housing, communications and furnishings, core inflation, which excludes volatile food and energy prices, remained elevated at 6.1% in January 2023, relative to 3.2% one year ago. Food inflation stood at 17.3% after experiencing a low of 7.9% in March 2022. Much of this was attributable to higher international food commodity prices, supply disruptions and adverse local weather conditions. Local inflationary pressures may continue to persist in the short-term as high shipping costs, potential rate increases, adjustment to higher fuel prices, foreign exchange challenges and the vulnerability of the economy from exogenous shocks continues to be elevated.
Even though estimates of a 6.6% YOY rebound in economic activity in Q2 2022, is being compared to a period of lockdown in the prior year, growth in different sectors are evident. Momentum in the non-energy sector may have slowed in Q3 2022 wholesale and retail trade (excluding energy) and manufacturing (excluding refining and petrochemicals). Nonetheless, economic activity is expected to improve, bolstered by the energy sector as several natural gas projects are carded to add to production levels and boost the upstream sector. Furthermore, OPEC’s recent production cut may keep energy prices elevated in the coming periods which may cushion T&T’s revenue base, barring any further shocks or deep recessions that could impact commodity demand.
The 1-year government bond yield increased to 1.20% in February 2023 relative to 1.06% in December 2022. Looking at the medium to longer term, the 10-year bond remained unchanged in February 2023 at 5.18%, from its December 2022 level. Additionally, the TTD/USD interest rate differential on three-month treasuries reached 4.29 basis points in February 2023. However, the Monetary Policy Committee of the Central Bank of Trinidad and Tobago (CBTT) maintained the repo rate at 3.5% in its quarterly meeting. This was prompted by the aforementioned instability in the financial sector and the possible slowing of inflation.
The CBTT may increase rates in the coming periods as business credit increased by 9.8% in December 2022, consumer credit improved, signs of growth became evident and as the central bank continues to monitor the liquidity in the local financial system. Contingent on local interest rate increases in the coming periods, banks can experience increased net interest margins which could boost profitability and benefit the financial sector in the stock market, which currently accounts for approximately 67% of the TTCI. This could provide an opportunity for investors to add or increase their portfolio’s exposure to banking stocks for growth in the medium to longer term.
Companies could experience margin pressures in the near term as volatility in the global economy continues, which could drag profitability if not managed efficiently. However, companies with some pricing power could possibly maintain or improve their profitability as they navigate current challenges. Thus, investors could seek companies with a diversified exposure, for instance local conglomerates, in products, geographies and currencies. Companies with strong pricing power and resilient balance sheets, such as those in the staples sector, could benefit.
Furthermore, medium to longer term investors should note developments on the Dragon Field project between T&T and Venezuela, from which gas flow could begin in 2 years, if materialized. That could substantially boost the non-energy sector of the economy as well, while shoring up government coffers and easing the burden of the perennially thin foreign exchange reserves.
Furthermore, while a shortage of fixed income options continues to present challenges to wealth preservation, investors could find value in (i) government guaranteed securities priced in line with the Trinidad and Tobago yield curve or (ii) corporate credits from borrowers with with strong balance sheets positioned to rally through economic pressures when available.
Written by:Leeann Ramdial & Sharda Goolcharan
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