Overall Market Summary:
After strong gains in the first half of 2023, global equities posted a negative return in Q3. Government bonds also declined, with yields rising. Commodities, particularly energy, outperformed due to oil production cuts from Saudi Arabia and Russia.
United States:
US equities weakened in Q3. Investors entered the quarter optimistic that the Federal Reserve (Fed) had achieved a soft landing for the economy and that the rate hikes would soon end. However, enthusiasm faded in August and September as the prospect of sustained higher rates became apparent, following a revised Fed “dot plot” showing higher interest rate forecasts.
The US labor market remains strong, although the unemployment rate rose by 0.3 percentage points to 3.8% in August, with 514,000 more unemployed persons. The US composite flash purchasing manager's index (PMI) fell slightly to 50.1 in September from 50.2 in August, indicating a cooling economy.
Inflation, despite ticking up in August, continues its downward trend. Fed comments suggest another rate hike before year-end, with a higher median rate forecast for 2024 (5.1% vs 4.6%).
Energy stocks were relatively resilient, standing out in a quarter where most sectors, including the "Magnificent Seven" (Apple, Microsoft, Alphabet, Amazon, Tesla, Nvidia, and Meta), declined. The IT sector, along with real estate and utilities, was among the weakest.
Europe:
Eurozone shares fell in Q3 amid concerns about the negative effects of interest rate rises on economic growth. However, data at the end of the period showed eurozone inflation slowed to a two-year low of 4.3% in September from 5.2% in August, potentially paving the way for the European Central Bank to end interest rate hikes.
Consumer discretionary saw steep declines due to concerns over higher interest rates affecting disposable income. The information technology sector was also under pressure despite enthusiasm for artificial intelligence, with near-term concerns over consumer spending affecting demand for chips.
The energy sector was a notable exception, gaining amid higher oil prices due to production cuts by oil-exporting countries. Financials outperformed, benefiting from rising rates, while real estate also posted positive returns.
PMI data indicated the eurozone private sector was in contraction, though the composite reading edged up to 47.1 in September from 46.7 in August. The European Central Bank raised interest rates twice in the quarter.
United Kingdom:
UK equities rose in Q3. Large diversified energy and basic materials groups outperformed, rebounding from Q2 weakness and benefiting from sterling weakness against a strong dollar. A sharp recovery in crude oil prices buoyed energy groups.
Domestically focused areas also recovered following poor Q2 performances amid signs of improving UK consumer confidence and hopes that base interest rates may have peaked. Market interest rates were relatively stable, with a moderated sell-off in long-dated gilts and falling long-term fixed mortgage rates, contrasting with the government bond market sell-off seen in other major developed economies.
Mid cap consumer discretionary areas, particularly housebuilders, recovered well. Travel and leisure companies, such as pub groups and transport operators, also outperformed, as did domestically focused banks and UK-exposed real estate companies. Inbound merger and acquisition activity among small caps supported UK small and mid cap equities.
Japan:
The Japanese equity market showed resilience during the Q3 market correction, triggered by rising interest rates and bond yields in the US and Japan. Large growth stocks were impacted, leading to a 4.0% decline for the Nikkei 225 index, while smaller stocks and value stocks held up well. The TOPIX Total Return index generated a modest positive return of 2.5%.
Quarterly earnings results, announced from late July to August, were solid, supported by the weakening yen and strong domestic demand. In late July, the Bank of Japan (BOJ) made policy adjustments endorsing a gradual increase in Japanese government bond (JGB) yields. There were suggestions that BOJ Governor Ueda could announce an end to negative interest rates by year-end or before the next spring wage negotiation. Inflation remained solid, and the continued weakness of the yen supported market expectations.
Rising interest rates in Japan and the US led to corrections in higher-valued stocks, particularly in the semiconductor sector. Financial stocks, including regional banks, performed well, as did the energy and auto sectors. Domestically-oriented mid and small-cap stocks performed well until August, but political tensions between China and Japan regarding the release of wastewater from Fukushima affected expectations for Chinese tourist demand in September.
Asia (excluding Japan):
Asia ex Japan equities declined in Q3. Most markets in the MSCI Asia ex Japan Index ended the quarter in negative territory due to concerns over the Chinese economy and global economic growth. Hong Kong, Taiwan, and South Korea were the weakest markets, while Malaysia and India achieved growth.
Mainland China experienced sharp declines, particularly in the property sector, as investors doubted Beijing's ability to deliver sufficient stimulus. Although China's official PMI manufacturing index rose in August, it marked the fifth straight month of contraction. China sought to boost confidence in its stock market by cutting stamp duty on share transactions and slowing initial public offerings in Shanghai and Shenzhen.
Hong Kong shares were also sharply lower, with trading of Evergrande shares suspended in September. South Korea saw falling share prices due to weaker factory output and slowing retail sales. Taiwan tumbled on fears that debt issues in Chinese property companies could trigger a financial crisis and weaken regional currencies.
Emerging Markets:
Emerging market (EM) equities declined in Q3 against a backdrop of deteriorating risk sentiment, concerns over a strong US economy maintaining higher interest rates, and ongoing weakness in the Chinese economy. Most EM markets posted declines.
Colombia and South Africa were the worst-performing markets, with their currencies depreciating against the dollar. Colombia's economic data pointed to a slowdown, while South Africa's weaker currency and softer commodity prices impacted performance.
China underperformed due to worries about slowing economic growth and property sector problems. Authorities announced stimulus measures, including interest rate reductions and lower down-payment ratios, to support the economy, particularly the housing sector.
Brazil lagged despite interest rate cuts and Congress's approval of a new fiscal framework. Korea was another laggard, while Taiwan outperformed despite delivering a negative return. Taiwan's July exports were better-than-expected, with tech exports growing strongly. Energy-heavy markets such as Kuwait, UAE, and Saudi Arabia were ahead of the index due to energy price strength.
India and Indonesia were down but outperformed the index, with India benefiting from foreign equity inflows. Inflation remains elevated. Hungary, Turkey, and Egypt were the only markets that rose in Q3, with Turkey benefiting from a larger-than-expected interest rate cut.
Global Bonds:
Global government bond yields rose in Q3, leading to declines in bond prices. In the US, the 10-year Treasury yield increased, influenced by expectations of sustained higher interest rates. The Fed's comments suggested another rate hike before year-end.
Credit markets had a weak quarter, with European investment grade pricing in a bleaker economic outlook, leading to negative total returns and wider spreads relative to government bonds. US investment grade credit underperformed European investment grade, but spreads were broadly unchanged versus Treasuries. High yield credit markets slightly outperformed government bonds.
The US dollar strengthened against all major currencies, benefiting from resilient domestic growth. Markets anticipated that higher rates for longer might be needed to bring inflation sustainably back to target.
Convertible bonds provided reasonable protection during most of the quarter but did not benefit from the AI-related recovery. The Refinitiv Global Focus convertibles index finished the quarter with a loss, reflecting subdued overall valuation in the secondary market despite good demand for new issues.