Clarion Investment Diary June 2023

The Clarion Investment Committee met on the 15th of June 2023. The following notes summarise the main points of consideration in the Investment Committee discussions but have been updated to include commentary on recent events and the wider implications for financial markets.

Economic, political and business snapshot

Economics

The Bank of England raised interest rates by 50bps to 5.0%, more than the 25bps hike expected. The committee voted 7-2 in favour, with the dissenting members voting to maintain rates at 4.5%. Inflation is expected to fall significantly this year. The second-round effects on domestic wages and prices are likely to take longer to unwind than they did to emerge.
The Office for National Statistics announced stronger-than-expected retail sales for May, with growth of 0.3% better than the 0.2% decline expected. Other data from GfK highlighted that consumer confidence improved more than expected in May. As noted by Next Plc this was partly driven by the improvement in the weather. Clearly, the recent rise in mortgage rates has yet to fully impact sentiment.
The euro area entered a recession with the region’s GDP shrinking by 0.1% in Q4 2022 and 0.1% in Q1 2023 driven by weakness in Germany and despite continued growth in France, Italy, and Spain. Consumption is under particular pressure – European consumers have lower levels of savings than their US counterparts and have been hit by rising gas prices.
German industrial production and euro area retail sales data came in weaker than expected underscoring the softening in growth in Europe.
UK annual house price inflation fell for the first time since 2012, with prices down by 1% in the 12 months to May, according to Halifax.
US services sector activity slowed unexpectedly in April, according to the ISM’s purchasing managers’ index.
New applications for US unemployment assistance rose to the highest levels since October 2021 in an early sign that the US labour market is cooling.
An FT poll showed that academic economists expected the US Fed to make at least two further 25bp rate hikes.
The Bank of Canada increased interest rates by 25bp following a pause in its rate hiking cycle as inflation has come in above expectations.
Chinese exports fell more than expected in May while the services activity grew sharply, painting a mixed picture for China’s economic recovery.
The Turkish lira fell against the US dollar last week as President Recep Tayyip Erdoğan’s economic team draws up plans for an ‘intentional devaluation.’
UK inflation slowed less than expected, with consumer prices rising 8.7% in the 12 months to May 2023, a similar reading to the previous month, in part due to rising prices for second-hand cars and air travel, offsetting a fall in energy costs.
UK core inflation rose to 6.8% in the 12 months to May, suggesting a continued persistence in inflation.
Expectations for UK interest rates rose on the news, with markets expecting interest rates to peak at between 5.5% and 6% later in the year.
UK government borrowing costs and mortgage rates, which closely follow interest rate expectations, also rose on the news UK energy regulator Ofgem announced that average UK household energy bills would fall to £2,074 a year from July.
UK retail sales grew by a greater-than-expected 0.5% in May following a drop of 1% in April.
The UK is estimated to have record net immigration of 606,000 people in 2022, roughly double pre-pandemic levels. The ONS cautioned that estimates are uncertain.
German statisticians revised their initial estimate for GDP growth in the first quarter of 2023 from 0.0% to -0.3%, meaning that Germany, having also recorded a contraction of 0.5% in the last quarter of 2022, entered a technical recession.

Business

The US Securities and Exchange Commission has sued the crypto-exchanges Binance and Coinbase over non-compliance with US securities laws.
Moody’s lowered Coinbase’s outlook to negative following the SEC lawsuits.
The FT reported that Lloyds Bank is to sell the Telegraph Media Group after pushing its parent company into receivership over debts owed by the Barclay family.
The EU announced plans for a mandatory ban on using 5G equipment from Chinese manufacturer Huawei, over national security concerns.
The chief investment officer of the UK’s National Employment Savings Trust, Liz Fernando, warned against the UK government’s plans to force pension funds to invest in certain domestic projects.
Morgan Stanley announced that it expects US corporate profits to fall 16% this year due to tighter credit conditions.
The world’s largest diamond jewellery retailer Signet Jewellers cut its full-year guidance as the luxury goods market is also hit by inflation and weaker demand.
A report by the Tony Blair Institute for Global Change called for UK pension funds to be amalgamated into ‘superfunds’ to boost investment in UK startups, businesses, and infrastructure.
The market valuation of the 14 largest private equity investment trusts is 36% below their reported net asset value, suggesting investors may be sceptical of the valuations reported by fund managers, the FT reports.
Netflix launched a crackdown on password sharing in over 100 countries, aiming to increase revenue from the estimated 100m people sharing accounts.
Norway’s $1.4tn sovereign wealth fund said that it would support shareholder motions to force oil majors ExxonMobil and Chevron to introduce emissions targets.
UK chemicals businesses warned that a failure by the UK government to introduce a new regulatory regime following Brexit risked causing them serious harm.
The German government is facing a backlash over its plans to ban new gas boilers in homes from next year.
US chip maker Nvidia issued a revenue forecast well above market expectations. Nvidia looks set to benefit from a rise in demand from AI (artificial intelligence), for which its chips appear well positioned

Global and political developments

UK prime minister Rishi Sunak said that the West will need to arm Ukraine for years into the future.
The US Navy accused China of growing aggression in operations including two “dangerous, unsafe, unprofessional intercepts” of US military vessels.
Pollution in New York has skyrocketed following wildfires in Quebec, pushing New York City public schools to cancel all outdoor activities.
A Russian-speaking criminal gang claimed responsibility for a cyber-attack, which has compromised the personal data stored by several large British companies.
Mike Pence, Donald Trump’s former vice-president, officially launched his candidacy for 2024 US presidential elections.
US federal prosecutors charged former president Donald Trump for the alleged illegal mishandling of sensitive national security secrets.
Spanish prime minister Pedro Sanchéz announced a snap general election after his Socialist party suffered heavy losses in local elections.
Turkish president Recep Tayyip Erdoğan narrowly won a run-off election against challenger Kemal Kılıçdaroğlu, by 52% to 48%
Russia launched its largest drone attack against Ukraine. Ukrainian officials said that 58 out of 59 drones were downed by air defences.
The EU is considering sending the profits from the almost €200bn in frozen Russian assets to Ukraine.
Russia claimed that it had reclaimed Russian territory that was briefly taken by pro-Ukraine militias.
Canada and Saudi Arabia restored diplomatic relations five years after Canada suspended them over Saudi Arabia’s human rights record.
Former UK prime minister Boris Johnson was referred to police over further potential breaches of lockdown rules.
Governor of Florida Ron DeSantis announced that he would run against former president Donald Trump to seek the Republican nomination in the 2024 presidential elections

To see Clarion’s Economic and Stock Market Commentary, written by Clarion Group Chairman Keith Thompson, please click here

Commentary

At the meeting on the 15^th of June, the investment committee reflected on the wider financial sector frailties following the fallout from the collapses of the Silicon Valley and First Republic Banks in the US. In Europe, the dramatic loss of confidence in Credit Suisse led to a deposit run-off at digitally-enabled speed and a total wipe-out of its statutory capital reserves, held in specialist bonds called Contingent Convertibles or ‘Cocos’.

These events are symptomatic of the sharp increase in interest rates, shrinking central bank balance sheets and the receding tide of global liquidity that had flooded the financial system for much of the past decade.

For those financial institutions that have relied too much on cheap liquidity by taking on too much leverage and aggressively mismatching their balance sheets, times will be challenging given their magnified exposure to bond duration risk. Should confidence in the banking system weaken further, this could result in contagion risks in other financial markets, particularly the leveraged pension funds. However, it was acknowledged that the major global banks are more robust than in the lead-up to the Global Financial Crisis, with global regulators requiring much greater capital and liquidity buffers.

Despite the financial challenges faced from higher interest rates, growth has been more resilient than expected. Aided by a decline in energy prices, with a mild winter in the northern hemisphere helping to reduce demand for natural gas, growth appears to have picked up in early 2023.

Alongside the rapid reopening of the Chinese economy following the lifting of Covid restrictions, global growth has been more resilient than expected this year.

The IC also discussed the stickiness of underlying inflation being higher than expected at this stage of the economic cycle, indicating a broad-based ability for companies to both pass on higher input costs and maintain (or even expand) margins. Wage growth across the major economies remains quite elevated, as a result of extremely tight labour markets. This is partly reflecting robust levels of demand, but also reduced labour supply, an issue which is particularly impacting the UK economy.

In the US productivity growth has lagged wage increases and this seriously questions the level of stretched P/E ratios in the US, should inflation remain higher for longer and when/if it reverts to the Fed’s original 2% target anytime soon. And the shape of the (inverted) bond yield curve traditionally has been a consistent signal of impending recession, so markets will continue to ponder with why it would be different this time?

The economic and financial market uncertainty created by recent events in the banking system is expected to leave central banks more watchful in the coming months over recession risks. That means that the rapid rate hiking cycles that have been running for a year or more may be paused, or even be coming to an end this year, with the exception of the UK where inflation forces remain elevated.

Despite the ongoing financial and geo-political volatility perturbing global market sentiment, the Investment Committee continue to remain focused on the analysis of long-term trends which are expected to impact a wide range of financial instruments. The process of periodic assumption setting is designed to avoid the over-emphasis of short-term transitory signals whilst remaining alert to strategic drivers of change. At this meeting, the IC approved only minimal changes to the long-term capital market assumptions, with the efficient frontier curve shifting marginally downwards and to the right for the lower to mid-risk benchmarks.

Equities

Despite the collapse of Silicon Valley Bank and other regional banks in the US and a dramatic loss of confidence in Credit Suisse which was subsequently rescued by UBS, global equities have remained resilient in the first half of the year, particularly in the US. Such surprising optimism was buoyed by receding recession worries in developed markets as commodity prices fell and lingering concerns of wider systemic risks in the financial sector being shrugged off, given the greater resilience of the major global banks post the global financial crisis of 2007/8. In an expression of confidence, the US Fed raised interest rates by 25 basis points in both February and March to their highest level since 2007. Further tightening was made by the ECB and the Bank of England to tackle stubbornly high and persistent inflation. There was also a sense of renewed optimism about emerging markets, given the re-opening of China’s economy, albeit tempered by re-escalating US-China tensions.

The performance in the US equity market has been quite strong, with the performance of the IA North America sector only bettered by the IA Japan sector amongst major IA sectors representing equity investments. By looking under the bonnet, however, one can see a more distorted picture. Seven stocks; Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla have essentially been the only drivers of the US equity market’s performance year-to-date, with the rest of the market delivering near zero or negative returns. It is likely that investors have been concentrating their positions in these stocks based on their exposure to AI. The key case study to this investor behaviour has been in Nvidia.

Nvidia is a technology company that designs graphics processing units (GPUs), application programming interface (APIs) for data science and high-performance computing as well as system on chip units (SoCs) for the mobile computing and automotive market. Nvidia’s GPUs are used in a wide variety of artificial intelligence applications, such as self-driving cars, facial recognition, and natural language processing. The growing adoption of artificial intelligence has led to strong sales growth for Nvidia’s data centre segment. However, the growth of Nvidia’s earnings has not kept up to the rate at which their share price has been rising. Nvidia’s PE ratio (price to earnings ratio) rose to over 100 times at its peak meaning investors were willing to pay 100 times the company’s earnings per share (EPS) for its stock. A high PE ratio can be a sign that investors are expecting strong future growth from the company. However, it can also be a sign that the stock is overvalued.

While there is excitement around the prospects of Nvidia and the potential future earnings that the company may achieve with advancements in AI, there is equally a lot of uncertainty on who will be the winners in an AI revolution. Looking throughout history, companies such as Nokia and Motorola seemed strong winners for the mobile phone market in early adoption of the technology, but ultimately failed to sustain their leadership with Apple and Samsung becoming the market leaders at a later date. Investors should be wary when valuing a company like Nvidia, which briefly became only the sixth trillion-dollar company, as these trends can reverse, and market share can change dynamically leading to significant losses.

Bonds

Central banks continued with their interest rate hikes against a volatile market backdrop with widening credit spreads. The US banking collapses in mid-March prompted a sharp rally in government bond markets, discounting the possibility of an earlier pause, or even an end to the hiking cycle. While there were signs that previous rate hikes were already biting (particularly in housing markets), their full impact on the broader economy is yet to be seen and concerns still linger over persistently high inflation data in both the US and Europe.

Strategy

As bond yields reached the highs of Kwasi Kwarteng’s budget announcement, the investment committee are considering adding more exposure to longer-dated bonds. However, a gradual approach will be taken with no major changes expected until yields on 10-year UK gilts approach 5%. For the time being, the committee continue to exhibit bias to short-dated strategies which are more resilient to interest rate rises.

The investment committee continue to favour the UK over the US on a valuation basis. The US equity market is still highly distorted, with a few large-cap technology companies driving the performance of US equity indices. The UK equity market, on the other hand, has a much broader base and should be more resilient to a high-interest rate environment due to its higher exposure to dividend-paying companies and companies in sectors that can remain profitable in the current macroeconomic environment.

The committee continue to favour Asia and Emerging Markets. While the re-opening of China’s economy had a profoundly positive effect on the performance of European, Japanese and commodity-driven stocks, the same effect has yet to have been realised in China’s equity market. While political headwinds remain strong in the region, the valuation argument outweighs the negatives. The Committee expect much broader outperformance in the region within the next 12 months.

The key themes are as follows:

Maintain current allocation to cash, fixed interest, and international equities. No net increase in equity exposure, although still committed to the diversification of equity holdings globally.
Underweight US with a preference for small and mid-cap companies. Underweight growth and mega cap technology companies which despite the fall in prices last year are still trading above historical valuation metrics.
Slightly overweight Emerging Markets, Asia & Japan.
Overweight UK.
Slight increase in duration in fixed income with a small move from short-dated bonds to medium-dated corporate bonds.
No changes to the underlying fund holdings other than to sell down Vanguard UK short-term bond fund in favour of Fidelity UK short-dated corporate bond fund due to the superior performance of the Fidelity fund over all time frames.
The Legal & General UK Mid Cap index fund has been chosen to replace the Slater Growth Fund on the basis of wider diversification focusing on mid cap companies and with a lower fund cost.

In the Committee’s view, central banks are likely to shift from the previous inflation target of 2% to a higher figure or a floating range, which will most likely be around 3-4%. The amount of economic destruction required to bring inflation back to a 2% target would be too great to be justifiable. Coupled with multiple developed economies (US and Europe) trying to ease the reliance on supply chains from China, inflation is likely to be stickier, although much lower than current levels, than initially thought.

Continuing to hold a globally diversified portfolio of high-quality assets is important to provide resilience and grow the value of savings over the long term and remains the appropriate method for allocation of investor capital. Cash is unattractive as inflationary pressures, although moderating, look to be structurally long term.

Keith W Thompson

Clarion Group Chairman

June 2023

Creating better lives now and in the future for our clients, their families and those who are important to them.

Clarion Funds & Discretionary Portfolios:

Defender Managed Portfolio

The chart below shows the historical performance of the Defender Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

	31/03/2022 to 31/03/2023	31/03/21 to 31/03/20	31/03/20 to 31/03/21
CIM DT03 Defender Portfolio	-7.11%	1.34%	13.46%
ARC Sterling Cautious PCI	-3.83%	1.62%	11.34%
IA Mixed Investment 0-35% Shares	-5.94%	-0.20%	12.09%

Changes to the Defender Portfolio

The Slater Growth P Acc fund was removed from the portfolio (1.80% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 1.80%)

Prudence Fund & Managed Portfolio

The chart below shows the historical performance of the Prudence Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

	31/03/22 to 31/03/23	31/03/21 to 31/03/22	31/03/20 to 31/03/21	31/03/19 to 31/03/20	31/03/18 to 31/03/19
MGTS Clarion Prudence P Acc	-7.44%	2.30%	18.26%	-7.89%	3.87%
CIM DT04 Prudence Portfolio	-7.58%	2.88%	18.24%	-7.42%	4.15%
ARC Sterling Cautious PCI	-3.83%	1.62%	11.34%	-2.29%	1.71%
IA Mixed Investment 20-60% Shares	-4.80%	2.73%	19.83%	-7.19%	2.86%

Changes to the Prudence Fund & Portfolio

The Slater Growth P Acc fund was removed from the portfolio (2.40% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 2.40%)

Navigator Fund & Managed Portfolio

The chart below shows the historical performance of the Navigator Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

	31/03/22 to 31/03/23	31/03/21 to 31/03/22	31/03/20 to 31/03/21	31/03/19 to 31/03/20	31/03/18 to 31/03/19
MGTS Clarion Navigator P Acc	-6.97%	2.81%
CIM DT05 Navigator Portfolio	-6.97%	2.81%	22.28%	-9.14%	4.12%
ARC Sterling Balanced Asset PCI	-4.32%	3.46%	17.86%	-5.44%	2.98%
IA Mixed Investment 40-85% Shares	-4.54%	5.23%	26.44%	-7.99%	4.30%

Changes to the Navigator Fund & Portfolio

The Slater Growth P Acc fund was removed from the portfolio (3.45% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 3.45%)

Meridian Fund & Managed Portfolio

The chart below shows the historical performance of the Meridian Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

	31/03/22 to 31/03/23	31/03/21 to 31/03/22	31/03/20 to 31/03/21	31/03/19 to 31/03/20	31/03/18 to 31/03/19
MGTS Clarion Meridian P Acc	-7.50%	1.50%	30.12%	-10.01%	4.27%
CIM DT06 Meridian Portfolio	-6.65%	1.76%	30.90%	-9.43%	4.28%
ARC Steady Growth PCI	-4.60%	4.64%	23.53%	-7.71%	4.85%
IA Mixed Investment 40-85% Shares	-4.54%	5.23%	26.44%	-7.99%	4.30%

Changes to the Meridian Fund & Portfolio

The Slater Growth P Acc fund was removed from the portfolio (3.45% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 3.45%)

Explorer Fund & Managed Portfolio

The chart below shows the historical performance of the Explorer Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

	31/03/22 to 31/03/23	31/03/21 to 31/03/22	31/03/20 to 31/03/21	31/03/19 to 31/03/20	31/03/18 to 31/03/19
MGTS Clarion Explorer P Acc	-7.41%	1.90%	34.77%	-9.05%	4.23%
CIM DT07 Explorer Portfolio	-6.44%	1.61%	35.28%	-10.10%	5.22%
ARC Equity Risk PCI	-4.80%	4.84%	30.35%	-9.65%	6.04%
IA Flexible Investment	-4.03%	4.95%	29.10%	-8.14%	3.31%

Changes to the Explorer Fund & Portfolio

The Slater Growth P Acc fund was removed from the portfolio (5.10% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 5.10%)

Voyager Managed Portfolio

The chart below shows the historical performance of the Voyager Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

31/03/22

31/03/23

31/03/21

31/03/22

31/03/20

31/03/21

CIM DT08 Voyager Portfolio

-6.00%

-1.91%

39.32%

ARC Equity Risk PCI

-4.80%

4.84%

30.35%

Changes to the Voyager Portfolio

The Slater Growth P Acc fund was removed from the portfolio (2.85% to 0.00%)
The L&G UK Mid Cap Index I Acc fund was added to the portfolio (0.00% to 2.85%)

Adventurer Managed Portfolio

The chart below shows the historical performance of the Adventurer Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

31/03/22

31/03/23

31/03/21

31/03/22

31/03/20

31/03/21

CIM DT09 Adventurer Portfolio

-4.13%

-5.07%

42.38%

ARC Equity Risk PCI

-4.80%

4.84%

30.35%

Changes to the Adventurer Portfolio

There was no changes made to the Adventurer Portfolio in June 2023

Pioneer Managed Portfolio

The chart below shows the historical performance of the Pioneer Portfolio against a relevant benchmark since the start of the available data.

The table below shows the annualised performance to the last quarter end:

31/03/22

31/03/23

31/03/21

31/03/22

31/03/20

31/03/21

CIM DT10 Pioneer Portfolio

-4.11%

-6.12%

45.66%

ARC Equity Risk PCI

-4.80%

4.84%

30.35%

Changes to the Pioneer Portfolio

There were no changes made to the Pioneer portfolio in June 2023

Risk Warnings

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.  The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds.  Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.