House View, July 2022
Asset Allocation: We have moved to an overweight position on equities in China in response to the country’s re-opening. But with a couple of other exceptions (most notably the defensive Swiss market), we remain neutral on equities overall as inflation persists and economies slow. However, prices are becoming more attractive and we maintain our interest in quality growth stocks and dividend payers.
Within an overall neutral stance on government bonds, we are finding increasing opportunities from moving out along the US Treasury curve, but we remain underweight euro periphery bonds. As financial conditions tighten and default rates rise, we are also underweight high-yield credits, but less downbeat on investment grade.
In currencies, we are positive on the Swiss franc and continue to see potential in select commodity currencies – as well as the beaten-down Japanese yen.
Macroeconomy: A global recession is looking increasingly likely. Yet, despite numerous economic headwinds, we expect central banks to continue to tighten monetary policy to tackle inflation that could well persist.
Believing the US could enter a mild recession early next year, we have revised down our US GDP growth forecasts to 1.9% (from 2.9%) in 2022 and -0.4% (from 0.8%) in 2023. Declining inflation and growth could lead the Fed to end its rate-hiking campaign at end-2022.
After 2.9% GDP growth in 2022, we now expect the euro area economy to grow by 0.8% (revised down from 1.8%) in 2023. We expect a mild, technical recession stretching over Q4 22 and Q1 23.
China is gradually recovering from strict covid lockdowns. Our forecast is that Chinese GDP growth of 4% this year could accelerate to 5% in 2023.
Commodities: Commodity prices are beginning to reflect the risk of recession. One exception is European gas, as Russia progressively closes the taps – and further gas disruption cannot be excluded. Our view on crude oil is that Chinese re-opening could compensate for a slowdown in developed economies, with Brent oil settling at around USD110 per barrel at year’s end.
Currencies: While threatened by energy shortfalls, other factors are turning more positive for the euro, including narrowing interest-rate differentials with the US as the European Central Bank (ECB) starts to hike rates. The unveiling of a credible ‘anti-fragmentation’ tool could enable the ECB to accelerate tightening, thus helping the single currency.
Equities: The rise in sovereign yields this year has driven down equity valuations. Unfavourable base effects mean the Q2 earnings season will be challenging, with year-on-year earnings set to shrink outside the oil & gas sector. Price-earnings metrics show US equites still commanding a premium over European equivalents, even adjusting for sector differences. While European equities thus look comparatively cheap, we remain neutral on European and US equities alike.
As we move closer to recession, we are relatively reassured about the health of US banks, which continue to return plenty of cash to shareholders. And while they face numerous challenges, aggressive ECB rate hikes will help euro area banks increase their margins. The main uncertainty facing consumer (particularly some consumer-discretionary) stocks is continued consumer forbearance of ongoing price increases.
Fixed Income: While long-term bond yields could remain volatile, we are neutral on developed-market government bonds generally, believing yields could decline from their current levels by year’s end. But we are still underweight government bonds in the euro area periphery as we do not expect the ECB’s fight against financial fragmentation will prove a bed of roses. With spreads still not fully pricing in recession risks, we remain underweight high-yield credits.
Asian Assets: Chinese equities’ performance has been improving as the economy re-opens, and we believe they could be an attractive play if markets elsewhere remain depressed. We are also positive on Asian investment-grade corporate bonds; while the yield premium has narrowed, it is still attractive when adjusted for risks. We also think the rebound in China will help Asian currencies (ex Japan).