Monthly Market Review - September 2023
Global markets continued their slide in September, as familiar concerns about inflation and higher interest rates persisted. The MSCI World Islamic Index fell by 3.3% in August, while the Dow Jones Sukuk Index fell 1.0%.
The big story in September was the rise in market interest rates, as measured by bond yields. In recent months the yield curve was significantly inverted, with short term (1-2 year) yields being much higher than longer term (10-20 year) year yields. This shape of the yield curve suggested expectations of a short (1-2 year) period of high interest rates followed by a longer-term period of lower interest rates, when economic conditions no longer warrant the current high rates.
In September, the shape of the yield curve changed to make longer term (10-20 year) rates much higher. The cumulative change was nearly 100 basis points in some cases, which resulted in a significant downward repricing of long-term bonds to yield interest rates close to 5% (in case of US 10-year treasuries), which are multi-decade highs.
The rise in market interest rates had a significant impact on both fixed income markets as well as equity markets, as higher interest rates means the present value of future earnings and cash flows is lower. Stock prices of companies whose cash flows are expected to occur mostly in the longer term future (i.e. growth companies) were more significantly impacted by the movement in interest rates.
Large tech companies, which are expected to grow and have higher future cash flows but are already cash flowing, were also impacted by the movements in interest rates, but they are also expected to be able to invest their free cash flows into fixed income products that now offer higher returns. As a result, these companies were more insulated from the impacts of higher interest rates.
Market participants have been keeping a close eye on economic data and central bank messaging for signs of how long interest rates will remain as high as they are now. The jobs and payroll data has continued to be strong, suggesting that inflation could persist over a longer period and lowering interest rates anytime soon would not be prudent.
While the US economy does not show signs of approaching a recession soon, market participants believe that interest rates cannot continue to rise without eventually inflicting some damage on households. In Europe, there are signs of a slowdown, but not necessarily a contraction.
Meanwhile, China’s economy is starting to pick up steam again, and the government is considering ways to open its stock market up to more foreign investment.
The overall picture of the global economy is that it is healthy, and as a result the weakness in the markets is primarily due to the higher discounting of cash flows. As a result, we believe that the recent dip in markets presents a good buying opportunity for investors on the sidelines, both for equities as well as sukuks. Higher discount rates, both in the short terms and the long term, means that equities and sukuks offer better value than they did before, and this could translate into better long term returns.
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