Diversify your portfolio, follow local and global markets!

-In April, markets were taken aback by the possibility that let alone holding the benchmark rate steady, FED could indeed consider raising the rates. While financial markets hoped for easing inflation and resilient macroeconomic fundamentals, instead all they got was resilient inflation and easing macroeconomic fundamentals. For example, the headline inflation in the US ticked up to 3.5% in April from 3.2% in March.

-The core inflation which excludes energy and food prices, even though remained the same at 3.8% vs. March, was higher than the forecast of 3.6%. In European Union both core and headline inflations came in higher than expected with 2.9% vs. 2.8% for the headline number and 2.4% vs. 1.7% for the core CPI. In the meanwhile, US quarterly GDP dropped to 1.6% in April vs. 3.4% in March and the University of Michigan Consumer Sentiment which dropped to 77.2 from 79.4 in March.

–There was a visible recalibration across the global financial markets, particularly in equities which took a dive in April. As of April 26^th, the US equity index S&P 500 and European stock index Euro Stoxx 50 dropped by -2.9% and -1.5% on the month. Emerging markets on the other hand remained relatively flat. Over the same period, global emerging market equity index MSCI EM was slightly up by +0.2% on the month and +2.4% on the year. The global equity market returns also reflected this reversal in the outlook with global equity indicator MSCI All Country World Index (ACWI) down by -2.5% in April.

-As of April 26^th, both Bitcoin and Ethereum were down on the month by -9.8% and -13.5% respectively. The duo maintained their significant year to date returns with +50.4% and +37.7% respectively. With elevated inflation in the back of investors’ minds, the price of gold continued its upside performance in April. This is because investors turn to gold as a store of value and a hedge against uncertainty and inflation. Hence, as of April 26^th, the first month futures contract for gold was up by a solid +4.9% on the month pulling its year to date return up to +13.3%.

-Even though some weakness in macroeconomic fundamentals cast a shadow on the expected demand, the ongoing conflict in the Middle East, a major oil-producing area, and production cuts by OPEC+ countries continued to threaten the future crude oil supply keeping the oil prices relatively flat in April. As of April 26^th, the first month futures contract for US crude oil WTI was up by +0.8% on the month, bringing its year-to-date return to +17%.

–With the election uncertainty out of the way, as of April 26^th, Borsa Istanbul Index BIST100 was up by a whopping +8.5% in local currency terms (+8% in US dollar basis) on a monthly basis springing its year-to-date return in local currency terms to an impressive +32.7% (+20.5% in US dollar basis). The monthly and year to date performance of BIST100 in US dollar terms underperforming its return in local currency terms is due to the appreciation in the greenback against Turkish Lira by +0.4% in April and +10.1% since the end of 2023.

–Investors can continue to exploit this scenario by a careful underweight in their equity allocations, possibly with a slight overweight tilt to their bonds, and/or other investments such as gold, US dollar and US dollar index which tend to provide a level of protection to portfolios in market downturns. This scenario could also allow for credit investments, such as corporate and high yield bonds, which are priced off of government bonds, to appreciate particularly for longer maturity instruments. Investors can still exploit more investment opportunities over the next 12 months than they could over the last decade. However, this requires proper risk diversification and staying on top of not just local but global markets on an ongoing basis.

If the markets ever had a crystal ball in their hands and were given the option to learn only one thing, that would likely be the timing of the US Central Bank FED’s rate cut… and as it turns out, it would have been great to have that crystal ball because without it a good chunk of the financial markets seems to have guessed it wrong so far. We know this because markets were taken aback by the possibility that let alone holding the benchmark rate steady, FED could indeed consider raising the rates. Before discussing how the markets responded to this not so new news, it is worthwhile to do a quick recap of the preceding couple months.

As our readers may remember, in our last issue we had noted that some of the international markets, particularly equities had a significant “melt up” since the beginning of the year on the back of resilient macroeconomic data alongside seemingly easing inflation which would be expected to lead to an eventual drop in interest rates. We had also noted that stocks tend to first move on the basis of “expected” data rather than waiting for the actual macroeconomic data or central bank rate decisions to be released. Then they course correct based on actual data as we discussed in our previous issues.

IN APRIL INFLATION CAME IN HIGHER THAN EXPECTED

Yet in real life, actual data rarely overlaps with the forecasts. In fact, sometimes they may even sit on the opposite end of the spectrum. This is exactly what happened lately. While financial markets hoped for easing inflation and resilient macroeconomic fundamentals, instead all they got was resilient inflation and easing macroeconomic fundamentals. For example, the headline inflation in the US ticked up to 3.5% in April from 3.2% in March. The core inflation which excludes energy and food prices, even though remained the same at 3.8% vs. March, was higher than the forecast of 3.6%. In European Union both core and headline inflations came in higher than expected with 2.9% vs. 2.8% for the headline number and 2.4% vs. 1.7% for the core CPI.

Slightly higher inflation vs. previous months or forecasts wouldn’t have been a major concern if it weren’t for weaker macroeconomic data. For instance, US quarterly GDP dropped to 1.6% in April vs. 3.4% in March and the University of Michigan Consumer Sentiment which dropped to 77.2 from 79.4 in March. Similarly in Europe the unemployment ticked up to 6.5% from 6.4% previously while in the UK it went up to 4.2% from 3.9%. The examples could be expanded, but the important takeaway is that in April markets realized that the macroeconomic fundamentals were not looking as strong or resilient and inflation could be stubborn. This meant if some of the leading central banks decided to raise rates, risk of recession would quickly be back on the table.

THERE WAS A VISIBLE RECALIBRATION ACROSS GLOBAL FINANCIAL MARKETS IN APRIL

As expected, this caused a visible recalibration across the global financial markets, particularly in equities which took a dive in April.

As of April 26^th, the US equity index S&P 500 and European stock index Euro Stoxx 50 dropped by -2.9% and -1.5% on the month, dragging their year to date returns to +6.9% and +10.7% respectively. Emerging markets on the other hand remained relatively flat. Over the same period, global emerging market equity index MSCI EM was slightly up by +0.2% on the month and +2.4% on the year. The global equity market returns also reflected this reversal in the outlook with global equity indicator MSCI All Country World Index (ACWI) down by -2.5% in April with +5.5% return since the year end.

BOND PRICES CONTINUED THEIR DECLINE DUE TO HIGHER INFLATION EXPECTATIONS

In April bond prices, particularly those with longer maturities, had a down month similar to equities. However, unlike equities this was not triggered by a reversal in sentiment. It was rather a continuum of the previous period as bond markets had already been expecting the rates to remain elevated a bit longer as we discussed extensively in a number of our previous issues. The only main change in April was that the shape of the US yield curve flattened a bit (blue line in the graph below) compared to March (red line). What that means is the shorter-term yields went down while the longer-term ones went up as illustrated below.

Source: Bloomberg

The reason for this partial normalization (the yield curve is generally expected to be upward sloping) was driven by the markets’ expectation of higher inflation. Just to remind our readers, when the yield curve is inverse, it means short term yields, which are generally driven by central bank rates, are higher than the yields on longer term government bonds which are driven by expected real rates and inflation in the long run.

In line with this increase in long-term bond yields, as of April 26^th, Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds and the High Yield Bond Index were both down -1.6% and -0.8% on the month dragging their year-to-date returns to -1.6% and +1.8% respectively. The Bloomberg Global Corporate Bond Index was flat maintaining its -1.8% loss since the beginning of the year.

NEGATIVE SENTIMENT ALSO WEIGHED ON CRYPTO PRICES

The overwhelmingly negative sentiment in the markets also weighed on crypto markets which had an impressive performance over the preceding three months. As of April 26^th, both Bitcoin and Ethereum were down on the month by -9.8% and -13.5% respectively. Despite their sizable losses, the duo maintained their significant year to date returns with +50.4% and +37.7% respectively.

GOLD HAD ANOTHER STRONG MONTH

With elevated inflation in the back of investors’ minds, the price of gold continued its upside performance in April. As a brief reminder, investors turn to gold as a store of value and a hedge against uncertainty and inflation. Hence, as of April 26^th, the first month futures contract for gold was up by a solid +4.9% on the month pulling its year to date return up to +13.3%.

CRUDE OIL MAINTAINED ITS RETURNS

Crude oil had a slightly positive month continuing its positive streak. As our readers wıll remember crude oil prices are driven by both demand and supply dynamics. Even though some weakness in macroeconomic fundamentals cast a shadow on the expected demand, the ongoing conflict in the Middle East, a major oil-producing area, and production cuts by OPEC+ countries continued to threaten the future crude oil supply keeping the oil prices relatively flat in April. As of April 26^th, the first month futures contract for US crude oil WTI was up by +0.8% on the month, bringing its year-to-date return to +17%.

TURKISH STOCKS HAD AN IMPRESSIVE APRIL FOLLOWING THE ELECTIONS

Despite the negative outlook in global equity markets, the Turkish stock market had a strong April on the back of the mayoral elections which took place at the end of the month. With the election uncertainty out of the way, as of April 26^th, Borsa Istanbul Index BIST100 was up by a whopping +8.5% in local currency terms (+8% in US dollar basis) on a monthly basis springing its year-to-date return in local currency terms to an impressive +32.7% (+20.5% in US dollar basis). The monthly and year to date performance of BIST100 in US dollar terms underperforming its return in local currency terms is due to the appreciation in the greenback against Turkish Lira by +0.4% in April and +10.1% since the end of 2023.

REVERSALS IN SOME MARKETS CONTINUE TO POINT TO GREAT RETURN OPPORTUNITIES

By end of March financial markets seemed to be overstretched either to the downside or upside which as noted in our previous issue could provide a lot of return opportunities for investors. To put it in perspective, just in the first quarter of the year equities and even crypto delivered returns that would be expected over a year or longer. Majority of this was based on “forecasts” or “expectations”. As April has clearly shown, investing based on such projections can pose danger in the absence of actual data. For instance, there are still a number of unknowns such as where global inflation will land and how resilient global economy will prove to be if interest rates stay high for longer.

The crude oil and more broadly energy prices remain as unknowns as well. The solid increase in crude prices which is an important driver of inflation globally, increases the likelihood that nominal rates may indeed stay higher for longer. To get a sense of crude’s impact on inflation, you can just look at some of the most recent headline consumer price index (CPI) numbers that include both energy and food prices some of which have ticked up as noted above.

MARKETS HAVE NOT FULLY INCORPORATED A RATE INCREASE

Last month we had noted that if this trend continued, which was likely, economists and market players alike could be in for a surprise with not just delayed rate cuts but potentially one or more rate increases. While markets are catching up to this possibility, a rate increase is not fully incorporated into the financial markets. This means there could be further weakness in markets that have been buoyed earlier by an exceptionally positive sentiment. Here we are particularly referring to equities and crypto markets amongst others.

Investors can continue to exploit this scenario by a careful underweight in their equity allocations, possibly with a slight overweight tilt to their bonds, and/or other investments such as gold, US dollar and US dollar index which tend to provide a level of protection to portfolios in market downturns. This scenario could also allow for credit investments, such as corporate and high yield bonds, which are priced off of government bonds, to appreciate particularly for longer maturity instruments.

Investors can still exploit more investment opportunities over the next 12 months than they could over the last decade. However, as always this requires proper risk diversification and staying on top of not just local but global markets on an ongoing basis.

ELA KARAHASANOGLU, MBA, CFA, CAIA

International Investments Director

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/