House View, February 2023
Global trade indicators are still below their pre-pandemic trend, but business sentiment seems to be stabilising in Europe, new orders have been picking up in emerging markets and global supply-chain bottlenecks continue to ease. China’s faster-than-expected reopening is a major factor in these improvements and has led us to raise our GDP growth forecast for the world’s second-largest economy from 4.5% to 5% this year. Thanks notably to a drop in energy concerns, and despite the prospect of further policy tightening by the European Central Bank, the euro area’s prospects have also brightened, leading us to up our GDP forecast for this year to 0.5% from -0.2%. The picture is somewhat less clear in the US, where household spending figures have lately been on the soft side, business sentiment in manufacturing has fallen and the Fed is still hiking rates. On current trends, we still think the US could experience a mild recession this year, with GDP contracting by -0.2%. We expect Japan to stay on a steady recovery path this year, with the possibility of adjustments to the Bank of Japan’s ultra-loose monetary policy after the appointment of a new governor in April.
Equities Equities rebounded solidly in January, with a drop in bond yields helping ‘growth’ style stocks and indexes in particular. Nevertheless, in their Q4 results, US companies generally reported a deterioration in fundamentals and provided poor earnings guidance. While underweight equities globally, we are tilting more towards European equities, where valuations are lower. We remain neutral on Japanese and UK large caps. Sector wise, we prefer European banks to US ones and continue to believe in the capacity of energy stocks to deliver. With a less aggressive Fed and with China re-opening, one might hope to see a normalisation of the performance of tech and communications services stocks this year, with similar factors possibly helping European consumer discretionary stocks. Emerging-market equities have gotten off to a particularly good start this year, with China’s re-awakening seen as further boosting the prospects for Asian stocks in particular.
Fixed income US and European bonds have rallied since the start of the year thanks to a lowering of markets’ inflation and policy rate expectations. In light of this rally, we have decided to move from an overweight to neutral position on US Treasuries as we see limited potential for long-dated US bonds to drop much further. Given that the European Central Bank probably has further to go on rate hikes than the Fed, we see continued narrowing of the rate differential between long-dated Bunds and US Treasuries this year. The January rally in risk assets in general has led to a tightening of credit spreads. However, poor economic momentum and the lagged effect of interest rates could trigger in rise in default rates and renewed widening of spreads over government bonds. Our preference therefore remains for investment-grade credits over noninvestment-grade ones.
Currencies, commodities As growth and interest rate differentials move in their favour, a number of currencies, including the euro and renminbi, have been making ground against the USD. Prospects for the yen look even better, especially if we see adjustments to the Bank of Japan’s yield-curve control policy after the appointment of a new governor in April. As a defensive and undervalued currency, we expect the yen to strengthen further against the USD this year. On the commodities front, Chinese re-opening, sanctions on Russian oil, and supply constraints elsewhere lead us to stick to our year-end target price of USD115 for a barrel of Brent oil.
Asset-class views and positioningIn equities, our preference is tilting toward European, Japanese and emerging-market stocks and away from US stocks—in line with our belief that we will see a convergence of risk premia. While the rebound in yields means fixed income has become a viable investment alternative to equities again, we remain selective and, in the credit space, prefer investment-grade bonds to noninvestment-grade ones. We are becoming more upbeat on the prospects for Asian assets in the wake of China’s rapid re-opening. We particularly like USD-denominated investment-grade Asian bonds, which will benefit from USD weakening and offer attractive carry. Narrowing rate and growth differentials mean we see a number of major currencies making headway against the USD this year.
Three investment themes
Convergence of risk premia. We think the convergence of risk premia in equity markets will shake up the opportunity set as valuation extremes converge. This means we think developed-market equities (in Europe and Japan) could again look relatively more interesting than US equities and emerging-market (especially Asian) equities more interesting than developed-market ones.
Fixed-rate rather than floating-rate debt. Countries where variable-rate debt is more prevalent are especially vulnerable to the rise in interest rates. This observation applies to these countries’ currencies, as well as their housing and banking sectors. This explains our preference for the euro and yen (places where fixed-rate debt is more common) to currencies like the British pound and New Zealand dollar, for example. We likewise prefer fixed-rate corporate debt.
Volatility as an asset class. Aware of the danger of complacency after a strong start to the year for risk assets, we continue to see the value of various option strategies to protect portfolios in the event of a pick-up in volatility.