Market Overview
While a defining feature of the first quarter of the year was the banking crisis in the US, the second quarter was very much about the exceptional growth and widespread adoption of artificial intelligence (AI). The hype has soared around tools such as ChatGPT and Google’s Bard and they have attracted huge levels of interest during the quarter. This has been a huge boost for tech stocks, large-cap tech stocks in particular. For example, Nvidia beat revenue guidance for the next quarter by about $4bn to $11bn, considerably higher than analysts’ expectations of $7bn in revenue. Other big names such as Microsoft, Facebook parent Meta, and Elon Musk’s Tesla have also led the way, while mid- and small-caps have generally underperformed.
Inflation has remained a challenge for the US Federal Reserve, which continued to hike interest rates before pausing in June. While headline inflation should come down, driven by a drop off in energy prices, core inflation is likely to be more problematic as the tightness of the labour market is keeping wage demands high. Borrowers in the US are also less sensitive to interest rate rises than elsewhere as mortgages are typically fixed for longer periods. Therefore, the US consumer is likely to be in a stronger position, and the economy may not cool as rapidly as elsewhere, which could keep inflation – and rates – higher for longer.
Fund Review
The fund produced a positive return during the quarter but from an attribution perspective, before charges, the portfolio underperformed the benchmark. The fund’s underweight in technology detracted from relative performance over the quarter. We were overweight Nvidia, which has done incredibly well, for most of the year, but decided to neutralise that position during the quarter after it reported its quarterly earnings. We believe there could be a risk of downside given how hard and fast the stock has run after the hype surrounding AI.
There were no significant changes to the portfolio during the quarter. Its largest overweight remains in consumer staples and largest underweights in technology and real estate.
Commercial real estate has generated a lot of negative headlines in recent months as it continues to battle the twin headwinds of a slower-than-expected post-pandemic return to offices and the higher rate environment. Many properties are highly leveraged and if they are not at full capacity it becomes difficult to service their loans. The financing side is also becoming more expensive as interest rates have risen materially. The issue is not just confined to offices; there have been signs of a slowdown across many other types of property. The prices of warehouses, for example, have increased strongly over the past decade as e-commerce took off, but we are now starting to see valuations go into reverse.
Outlook
We remain cautiously optimistic for the third quarter, and believe there is still room for further upside in US equities. Nevertheless, the outlook is becoming a bit more challenging.
The decade of ultra-low rates benefited equity markets as many institutional investors sought better returns outside of fixed income. However, fixed income is now starting to look more attractive as higher yields from less risky assets allow investors to de-risk and reduce equity exposure. This has resulted in some movement of capital away from equity markets. That said, there are still positive trends and themes emerging in equity markets such as the nascent AI industry.
Equity markets also tend to be more exposed to the US economy than other asset classes, which should be helpful for valuations as the US economy rebounds. In the US there has been some debate about when a recession could hit and, if it does, how deep it would be. However, the strength of the labour market has led some to believe that a slowdown would be slower and shallower than in many other countries, largely because US consumers are far less sensitive to interest rate hikes.
Important Information
The value of investments may fall as well as rise and investors may not get back the amount invested.
Due to the underlying assets held in the LF Canlife North American Fund, the price of the fund is classed as having above average to high volatility.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available in the literature section.
Promotion approved 20/07/23
