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Market Insights

In the US, the debt ceiling impasse between Democrats and Republicans generated headlines over May. Despite the drama, equities were relatively resilient with the S&P 500 rising by 0.4% (USD). By month-end the VIX Index, which measures volatility for the S&P 500, traded below 18 which is at the lower end of the post pandemic range. “AI,” or Artificial Intelligence, has dominated headlines across all the financial channels throughout the month of May. Anything AI” has dramatically outperformed the broad market this year. Growth outperformed Value in May. The Russell 1000 Growth Index gained 4.6% (USD) for the month, while the Russell 1000 Value Index lost nearly 4% (USD). The Nasdaq 100 Index, which is heavily weighted in the tech space gained 7.7% (USD) in May. In contrast, the Dow is flat for the year. Some might caution about market breadth as seven of the top eight stocks in the S&P 500 by market cap are primarily responsible for all the 2023 gains. Equity market leadership in the US is very narrow. Large tech companies outperformed the broader market, backed by strong earnings reports and growing investor expectations about the future potential of AI. US inflation temporarily bounced in April, with headline and core CPI (consumer price index) both rising 0.4% month-on-month, roughly in line with expectations. In the May meeting Fed Chair Powell said that the FOMC might be inclined to pause future rate hikes but is not thinking of cutting rates soon. There is a sense that we are much closer to the end of the tightening cycle than the beginning.

On growth, recent data has been generally comforting. April saw somewhat stronger-than expected auto sales, housing starts and employment numbers, suggesting that real GDP is continuing to grow in the second quarter. Despite volatility in the banking sector that led to a sharp selloff at the start of the month, regional banks have rallied somewhat as the fear of contagion dissipated into month’s end. The KBW Regional Bank Index closed the month down 9%. Treasuries finished May with gains across the curve. The yield on the benchmark U.S.10-year Treasury now sits at 3.64% compared to 3.43% at the end of April.

The 30-year yield now sits at 3.86%. According to FactSet, S&P 500 companies reported the 2nd straight quarter of Y/Y declines. However, index members did record their best earnings performance relative to analyst expectations since Q4’21. With nearly all the S&P 500 constituents reported, 78% posted a positive EPS surprise, while 76% had a positive revenue surprise. The dollar rose over 2.5% in May, closing at monthly highs following two months of declines. Stronger-than-expected jobs data and somewhat sticky inflation lent support to the dollar.

So far, the equity uptrend has relied on mean reversion and truncated tail risks. Moving ahead, the optimistic outlook for a bull market is based on four major macro factors: no severe recession, lower inflation rates, decreased real interest rates, and the resolution of deflationary pressures in China. The Federal Reserve will closely monitor the progress of these macro pillars and adjust its actions accordingly. In contrast to the previous year, the financial markets are now inclined to anticipate and react to potential easing measures by the Federal Reserve, rather than being discouraged by strong language from the central bank.

Nevertheless, the lack of major imbalances warns that any economic contraction should be moderate and take time to play out. A shortage of
housing supply is putting a floor under prices and, therefore, the impact on household wealth. Despite the ongoing regional banking crisis, there are currently no indications of it spreading throughout the entire banking system. In fact, large banks will benefit from consolidation in this sector. Additionally, the highest point of headline PCE inflation occurred a year ago, which reduces the pressure on the Federal Reserve to continue implementing strict monetary policies without first evaluating the impact of previous measures.

South Africa

In the past month, local equities experienced significant declines as indicated by the FTSE/JSE All Share Index and Capped SWIX, which fell by 3.9% and 5.8% respectively. The resources sector was particularly affected, with a 2.2% loss. Companies like Thungela Resources (-19.9%), Sibanye-Stillwater (-13.3%), and Exxaro Resources (-11.2%) were among the major contributors to these declines. The industrials sector also experienced a 3.3% decrease, mainly driven by the downward movement of Naspers (-8.7%) and Prosus (-5.4%), although Richemont’s positive gains (3.8%) partially offset the losses. During this period, the South African rand weakened against the US dollar, euro, and pound sterling. The National Treasury provided an update to Parliament on the financial status of various state-owned enterprises, with Eskom being the standout underperformer. Eskom reported a loss of R21.2 billion for the 12-month period ending in March 2023. The South African Reserve Bank (SARB) released the first edition of its 2023 Financial Stability Review, which highlighted that nationwide load shedding is expected to have a negative impact of two percentage points on overall economic growth this year. South Africa’s relationship with Russia gained attention following allegations by the US that the South African government had loaded weapons onto a vessel sanctioned by the US while it was in local waters. Additionally, the SARB implemented a 50 basis points increase in the repo rate, bringing it to 8.25%, in line with market expectations. In April, annual inflation reached an 11-month low of 6.8%, while core inflation rose to a six-year high of 5.3%.

All performance figures in ZAR unless otherwise stated.

View from Scottish Mortgage

Growth and innovation are not dependent on the direction of macro-economic developments. Instead, we pay close attention to exponential trends such as Moore’s Law in semiconductors, Carlson’s curve in genomic sequencing or Wright’s Law in manufacturing. These predictable trajectories of progress are a valuable way to understand what is happening in the world. A feature of these laws is that progress each year can underwhelm but cumulative progress over a decade or more is remarkable.

Tom Slater, Scottish Mortgage

The Iza Portfolios

The Iza Global Equity Fund rose by 0.06% in May. While the Iza Global Balanced Fund declined by -0.27% for the month. The Stable Model Portfolio declined by -0,46% for the month. (All GBP returns).

Looking at the portfolio’s underlying fund managers the portfolio’s largest detractor was the Fundsmith Equity Fund which declined by 3.3% for the month. Fundsmith has exited their position in Amazon during the month. Fundsmith’s top 5 contributors in the month were Microsoft, Meta Platforms, Alphabet, Amadeus and Apple. The top 5 detractors were Estée Lauder, L’Oréal, Waters, Philip Morris and Stryker. The Invesco Sterling Bond Fund declined by -1.98% over the month of May. While the Royal London Sterling Extra Yield Fund gained 0,23% for the month. Scottish Mortgage was the portfolio’s largest contributor for May gaining 5.9% for the month.

Scottish Mortgage faced challenges throughout 2022 and the initial period of 2023. Investors flock to assets that are already proven and profitable during times of macro pressure. However Scottish Mortgage believes that Buying predictability may provide temporary comfort, but it is by embracing discomfort that we can entertain the possibility of outsized returns from exceptional companies. The universe of businesses with bounded opportunities and well-analysed competitive positions is unlikely to yield extraordinary outcomes. Looking ahead the larger question for the market is whether the rally in tech stocks will spread to other sectors or if the “long and variable lags” in Fed policy and tighter credit conditions will impact corporate earnings in 2H.

Funds’ Performance Summary

This year’s equity market rally has been challenged by narrow breadth of S&P 500 returns. Past episodes of similar breadth have delivered lackluster short-term performance, but returns have historically surged a median 10% in the 12 months following. A “catch-up” effect from remaining index constituents reflects a key catalyst sustaining this rally. Alongside resilient economic growth and corporate earnings, Goldman Sachs has raised their S&P 500 year-end price target to 4500.

Source: Goldman Sachs

Investors are crowding into a shrinking number of stocks, the chart below shows that “anything AI” has dramatically outperformed the broad market this year, while the rest of the S&P 500 is flat over that period. Moreover, implied equity volatility (VIX) is at a 3-year low.

Source: Alpine Macro 2023

Asset Class Performance (Base Currency)