Against a backdrop of deteriorating economic data, the FTSE 100 continues its upward trajectory. Since the beginning of the year, the index is up 7.5%, pushing past the 8,000-point mark for the first time in its history.
On the other side of the pond, it’s a similar story. The S&P 500 is up 8% and the Nasdaq Composite 15% in 2023. Markets are becoming increasingly confident that central banks will be successful in pulling off a soft landing. However, I remain to be convinced.
Falling inflation
Figures released from the Office for National Statistics this week, show that inflation has fallen for the third month in a row. Over the past 12 months, prices rose by 10.1%. In the US, the rate stands at 6.4%.
Falling inflation is good for markets. It means that central banks won’t need to keep hiking interest rates. However, I’m far from convinced that inflation is dead.
We’ve already witnessed what happens when economies reopen rapidly. Flush with savings from being locked down, people go on a spending spree, putting pressure on supply chains. This could very well repeat itself following the reopening of China, the second-largest economy in the world.
Secondly, commodities have been rallying lately. This includes base metals such as copper, zinc and iron ore. Agricultural commodity prices continue to rise on the back of rising fertiliser prices.
Bear market rally
The recent rise in equity markets I attribute to a bear market rally. The animal spirits that we witnessed during 2021 have come back in 2023.
In my opinion, too many analysts are pricing in a mild recession as their base case. The tightening of financial conditions that we witnessed in 2022 were unprecedented. But successive interest rate hikes take time to filter through the economy.
We’ve already seen the first cracks developing. The housing market has cooled off significantly. Cancellation rates have rocketed. Earlier this week, the Barclays share price fell heavily in response to a significant increase in impairment charges.
FTSE 100 to outperform
Despite my overlay negative sentiment toward equity markets, I remain bullish on certain sectors. Oil and gas, base metals and precious metals make up a significant chunk of my portfolio.
One of the reasons why the FTSE 100 outperformed the US market last year, is because it’s jam-packed with commodity-related businesses. I see it continuing to outperform.
Although I’m expecting a deeper and longer recession than many analysts, I remain bullish on the likes of BP, Shell, Glencore and Anglo American.
Chronic underinvestment across critical natural resources is likely to be the next narrative in the inflationary story. Indeed, I expect a situation similar to the 1970s. Throughout that decade, inflation went up in three distinct waves, each peppered with a disinflationary cycle.
Driven by the political and social pressure for the world to accelerate decarbonisation, I believe the 2020s will be characterised by inflation. If so, then the winners of the last decade, the tech stocks, are unlikely to come out on top again. For me, we’re only at the beginning of a commodities bull market, and my portfolio reflects that conviction.
