Market review
The third quarter marked a pivotal shift as the US Federal Reserve (Fed) delivered a 50bps rate cut, prompted by inflation nearing its 2% target and rising unemployment. Initial market concerns over recession faded as focus shifted to economic stability, resulting in equity markets rallying. This prompted a notable rotation away from what many view as overbought tech stocks, into small-cap and value stocks.
In fixed income, upgrades exceeded downgrades for the first time since early 2022, and speculative-grade default rates declined. Corporate bond issuance rose, reflecting strong demand, and total returns were positive across the US, Europe, and the UK, reinforcing the case for diversification between equities and bonds.
For UK investors, gains in global equities and unhedged fixed income were eroded over the quarter by the strengthening pound. Budget-related uncertainty reversed a little of this in late September.
In Asia, Chinese government policy support boosted returns for Chinese assets and global companies with significant exposure to the region. While geopolitical risks remain, further domestic policy support could signal a rebound for China's economy.
Fund activity
During the quarter, the fund produced a positive return but underperformed its sector. The main drag on relative performance was the allocation to US technology, and to global unhedged bonds as the pound strengthened. However, duration management (a move from short duration gilts to mid duration) added value over the quarter, as did the REITs and infrastructure holdings as these asset classes continued to improve.
In terms of fund changes, our reduction of the allocation to short-dated gilts in favour of longer-dated gilts came as we enter a rate-cutting environment, and we also switched some hedged global bonds into unhedged. Hedged bonds had been protected from the rise in sterling, but less so of late due to hawkish news from the Bank of England (BoE). Given the uncertainty of currency risk, we now prefer a mix of hedged and unhedged.
Outlook
Interest rates remain a key focus for markets as we approach the final quarter. The Fed has signalled a slightly hawkish stance, to which markets responded positively. The BoE echoed similar views, impacting currency markets, with any further fall in sterling likely to boost non-sterling asset returns.
Markets are currently pricing in three US rate cuts for 2024, which we consider ambitious. We would not be surprised to see this expectation revised closer to the next Fed meeting. We believe the US market will maintain its bullish trend, with consensus leaning toward a soft or potentially no landing scenario for the economy.
In the UK, investors are preparing for a challenging budget, with uncertainty driving short-term volatility. We see better near-term opportunities abroad. Europe, particularly France and Germany, faces growth and political stability issues, leading us to focus on peripheral regions such as Spain and Portugal, as well as companies with global exposure.
China remains a potential market mover, especially if policy support continues. Beneficiaries could include emerging markets, Asia-Pacific, and global companies with high sales exposure in the region, such as luxury goods and beauty sectors.
Overall, we hold a cautiously optimistic outlook for US and Chinese markets, with mixed prospects for Europe. In fixed income, we favour a shift away from US treasuries towards gilts, with increasing allocations to non-hedged global bonds. Interest rates and currency movements will be critical, and diversifiers like gold offer protection against growing government deficits and geopolitical risks.
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Important Information
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
The WS Canlife Portfolio Funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the funds. The value of the property is based on the opinion of a valuer and is therefore subjective.
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