Weekly Update - First half of 2023 was good for equities

During the first semester, different markets seemed to be trading different economic scenarios. Equities, which rallied strongly with low volatility, were betting on a modest slowdown and inflation falling back to more comfortable levels. Bonds, meanwhile, and commodities even more so, seemed to be pricing in a severe slump brought on by tighter monetary policies. While it was a good semester for equities, the issue of a harder landing for economies only seems to have been delayed.

Developed economies have held up well. This deeply atypical economic cycle has continued during the first half of the year 2023, defying the most pessimistic scenarios. Measures to rein in inflation and monetary policy clampdowns were offset by the still solid balance sheets of households and companies. Services were especially strong, helping sustain the improvement in jobs markets. Even the European economies, which had borne the brunt of the Russian gas and oil shock, proved resilient. We also got confirmation that inflation had peaked. However, sticky underlying inflation persuaded central banks to continue their restrictive policies. In the major emerging economies, China's post-Covid reopening has only be followed by a slow recovery in domestic demand, prompting the authorities to ease policy.

Equity markets powered by large caps. Equity markets rallied strongly in the first half of the year, riding the resilient economy and healthy news flow on corporate earnings. The bank wobbles seen in March were quickly corrected, although the banking sector continues to be marked down in consequence. In the United States, the AI boom boosted the Nasdaq (up 40% YTD), while in Europe a handful of large caps (notably from the Luxury sector) accounted for much of the positive performance. Interestingly, the Japanese market had some specially strong performances although these were less impressive in euro or sterling terms due to the ongoing slide in the yen. Emerging equity markets were held back by the weak Chinese recovery.

Bond markets are again playing a protective role. 10-year yields ended the half-year virtually where they had started, despite high volatility. Although bonds had fallen alongside riskier assets in 2022, there was a clear return to a negative equity/bond correlation in the first half of 2023, most obviously during the banking turbulence. UK gilts again bucked the trend this semester, with big rises in interest rates to address the country's unexpectedly stubborn inflation.

Overall, equities amply outperformed in the first half of the year, confirming our scenario that the economy is heading for a fairly soft landing. Trends so far in the second half od the year, however, show this is not a done
deal and a harder landing remains on the cards.

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