Has the Federal Reserve "done enough"? Markets seem to think so

Spotlight: Examining the Healthcare Sector

During the festive season in Japan, it is common to see life-sized statues of Colonel Sanders, dressed in red satin Santa Claus outfits outside KFC branches. This tradition has become a symbol of an unusual Christmas ritual in the country. Around four million Japanese people annually enjoy what's known as the "KFC Special Christmas Dinner" over this period. In contrast, in the UK, while KFC promotes its chicken, many of us tend to opt for a traditional homemade Christmas dinner instead. However, the bigger problem lies in the eating habits prevalent in our daily lives beyond the holiday season. Japanese dietary habits are among the healthiest globally, while in the UK, our routines often revert to unhealthy eating and lifestyle habits. This behaviour contributes significantly to the ongoing obesity epidemic in the UK. Latest studies show that Britain’s expanding waistline is now costing c£100 billion a year, negatively impacting national productivity by up to nine times more than previously thought, (source: Tony Blair Institute for Global Change).

When focusing on Healthcare as a sector, the MSCI World Healthcare equity index has had negative performance through 2023 at -4.0%, a material underperformance relative to the MSCI World index, which has returned +20% (see chart below). This underperformance in healthcare stocks is primarily attributed to weak earnings-per-share growth observed during this period, (earnings per share is a measure of a company’s profitability on a per share basis). Consequently, negative sentiment has affected the sector, leading to a slight decrease in the index's price-to-earnings ratio (a measure used to gauge whether a stock is under or overvalued in relation to its earnings). Despite this recent downturn, the healthcare sector shows signs of future promise. Alongside the obesity epidemic noted above, there has been a noticeable increase in the development of anti-obesity drugs, which holds promising prospects for healthcare stocks. The UK Government announced in June that it was rolling out a £40 million two-year pilot (source: gov.uk), making anti-obesity drugs more widely available outside of hospitals, which is expected to have a positive impact on the industry, with anti-obesity drugs having the potential to become the biggest category of pharmaceuticals in medical history (source: Hargreaves Lansdown).



 
Healthcare is typically considered to be a low volatility, defensive sector. Market analysts predict a return to material positive growth next year for the sector; fuelled by advancements in new pharmaceuticals like Ozempic (an anti-obesity drug). Looking ahead, we continue to see leading indicators (i.e. signals that suggest the future direction of the economy or financial markets) pointing towards an economic slowdown or a contraction. Historically, such environments have been favourable for the healthcare sector compared to the broader index as demand for healthcare tends to be insensitive to the economic cycle. Additionally, current valuations may not fully reflect the growth opportunities in new drug areas especially given the government’s plans to increase investment in the sector.
 

The noise

• The UK economy shrank in October according to official data from the Office for National Statistics, adding to the likelihood of a recession in 2024. Gross domestic product (GDP) fell by 0.3% from September, coming in below economist expectations that growth would be flat. Britain’s dominant services sector shrank by 0.2% in October and manufacturing and construction also contracted by 1.1% and 0.5% respectively. Severe weather in October affected retail and tourism, with household spending impacted by higher interest rates as the Bank of England tackles inflation.

• The European Central Bank (ECB) left interest rates unchanged as expected on Thursday, while also pushing back against bets of imminent rate cuts. The ECB’s policy rate remains at a record high of 4%, with ECB president Christine Lagarde reaffirming that borrowing costs would remain at this record high despite lower inflation expectations. She emphasised that “we don’t think that it’s time to lower our guard, there is still work to be done”, though market participants point at the latest inflation figure of 2.4% being sufficiently close enough to 2% to at least consider rate cuts.

• Delegates from almost 200 countries reached an agreement at the COP28 climate summit to being reducing global consumption of fossil fuels, in what was described as a historic deal. The deal struck Wednesday following two weeks of intense negotiations aimed to convey a powerful message to investors and policy-makers, emphasising global unity in the determination to transition away from fossil fuels. More than 100 countries pushed hard for strong language in the agreement to “phase out” fossil fuel use, but the faced fierce opposition from OPEC (Organisation of the Petroleum Exporting Countries) members. Some of the specifics of the deal include calls for governments to triple renewable energy capacity globally by 2030, speed up efforts to reduce coal use, and accelerating the development of technologies such as carbon capture and storage.

The numbers

GBP Performance to 15/12/2023

Source: Bloomberg, data as at 15/12/2023

The nuance

“We’ve done enough” said US Federal Reserve chair Jerome Powell on Wednesday as policymakers state-side left interest rates unchanged for the third straight time and set the table for multiple cuts to come in 2024 and beyond. The Federal Reserve’s latest projections showed that they had pencilled in at least three rate cuts for 2024, less than what markets had been pricing in but more aggressive than what officials had previously indicated. US inflation has eased faster than expected which is what’s allowed the Federal Reserve to bring rate cuts into view.

Our side of the pond, the Bank of England also stuck to its guns on Thursday and kept interest rates at its 15-year peak of 5.25%, with the monetary policy committee voting 6-3 to keep rates on hold. Bank of England Governor Andrew Bailey’s statement delivered a different message to the one delivered by his US peer, as he reiterated a need for rates to stay high for an extended period. He added that there was “still some way to go” in the fight against inflation, challenging investors who have bet increasingly on rate cuts. Indeed, the Bank of England’s policy stance assumes a slow fall in interest rates to 4.25% in three years' time, contrasting market sentiment that rates will drop to that level by the end of 2024. Such divergence in monetary policy particularly between major economies can tend to have implications for financial markets, especially currencies. This may go some way to explaining the recent strength in Sterling relative to the US dollar, as interest rate expectations from the US have come down significantly in recent weeks.

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