Annualised performance data in euros at 31st August 2023

The last three years have provided us with some of the most volatile periods of inflation in decades. How has inflation impacted equity performance during this time and how will inflation continue to impact equity returns going forward? In general, equities tend to do better than cash and bonds during inflationary periods but underperform real assets like commodities. This is the case as long as inflation does not become a persistent problem over time.

During the initial phase of an inflationary period, equities tend to perform quite well. Rising inflation generally leads to rising nominal demand and rising corporate sales and profits. Companies tend to pass on cost increases to customers and therefore maintain healthy corporate margins. However, rising inflation eventually leads to rising interest rates as central banks tighten monetary policy to ensure price stability.

This cycle, equities have performed well to date, despite multiple interest rate increases. The US consumer has been a leading source of resiliency in the economy. US household consumption continues to be the largest contributor to quarterly economic growth. Corporate revenues and earnings have been robust. As such, Managers continue to maintain a more positive view on equities.

We have pointed to a slowdown in job openings in recent months and also note that credit card delinquency rates have also picked up recently. So, perhaps the US consumer is starting to feel the pinch. Consumer confidence levels may also have peaked for this cycle.

Outside the US, Japan continues as this year’s best performer, +12% year-to-date in euro terms. European equities have added +10%, UK equities +3% while emerging markets have gained just +2%, with China continuing to be the key underperformer in Asia.

China’s ongoing problems are largely property related. After a decade long bull market in real estate, the air is coming out of the sector, causing problems some for President Xi Jinping and his citizens. A number of China’s largest real estate developers recently filed for bankruptcy. It will take years for the excess to be worked out of the system. The Shanghai Composite Equity Index has gone nowhere in over a decade, despite robust economic growth during this time. Some suggest the Chinese miracle has been illusory and has led to the enrichment of the corporate and political classes at the expense of the Chinese people. President Xi has a problem on his hands. GDP growth is falling. Youth unemployment is uncomfortably high. A currency devaluation may be considered to improve export growth and boost GDP. While this would benefit the corporate sector, a weaker currency makes goods and services more expensive for Chinese citizens. A devaluation of the yuan versus the US dollar would also have the practical effect of exporting deflation abroad, which would adversely impact equity markets should it occur. There are no easy solutions here.

Emerging market equities are attractively priced today and should benefit from a falling US dollar. However, we would recommend avoiding Chinese equities when looking for opportunities in Asia.