Monthly house view | April 2023
Recent weeks have seen an improvement in global business sentiment, especially in emerging markets on the heels of China’s re-opening. International trade has also been showing some encouraging signs. Nonetheless, due to the tightening of funding conditions (even before recent banking stress) we think the US could enter a recession in the coming quarters. With inflation expectations staying anchored, we have lowered our expectation for further rates hikes from the Federal Reserve. While there have been some signs of fragility in the banking sector in Europe too, business confidence there has been improving. With core inflation proving sticky, we expect further rate hikes from the European Central Bank this quarter. China’s past-lockdown recovery is advancing, with a noteworthy surge in services activity. Given targeted policy support designed to maintain economic momentum, we are sticking to our GDP growth forecast of 5% for this year. Elsewhere in Asia, ASEAN economies continue to benefit from the reconfiguration of global supply chains, while we expect GDP growth in India to reach 6% this year—among the highest for any large economy. Under its new governor, we expect only gradual policy normalisation of the Bank of Japan’s ultra-accommodative monetary policy.
Equities While still ahead year to date, the performance of the Stoxx Europe 600 lagged that of the S&P 500 in March. This reflected the strong rebound in prices for tech titans as bond yields declined. But earnings growth in the US is becoming scarce. We believe earnings metrics on stock indexes in Europe look better and have therefore moved from an underweight to a neutral position on euro area equities while we remain underweight their US peers. Despite recent one-off events, our preference continues to go to European banks over banks in the US, which are exposed to increasing funding costs as deposits seep out of banks (especially smaller and regional ones) and into money-market funds.
Fixed income Bond markets experienced significant volatility in March, but bond yields dropped over the month as a whole as fragilities in banking systems pushed market participants to reprice downwards their expectations for central banks’ rate policy. Given the increasing likelihood of a US recession, we remain overweight US Treasuries and have been extending our duration to maturities in the 7-10 year range. Turbulence in banking had the effect of widening spreads on corporate credits in the middle of March, but spreads had tightened again by the end of the month. Given credit tightening and prospects for an increase in default rates, we prefer to remain underweight noninvestment-grade bonds and neutral on investment-grade (IG) bonds, seeing short-duration IG bonds as offering attractive risk-adjusted returns.
Currencies, commodities, real estate An over-valued US dollar has been penalised in recent weeks by banking vulnerabilities in the US and reduced prospects for additional monetary tightening by the Fed. We believe the euro and yen could be among the main beneficiaries of a weakening US dollar. In commodities, any fall in oil demand because of economic weakening in the US could be compensated for by resilience in Europe and Asia, as well as by supply discipline on the part of oil producers (witness OPEC+’s announcement of a production cut at the start of April). We are therefore sticking to our forecast for higher oil prices by the end of this year. In private real-estate investing, we believe that recent strains in commercial property should be seen as an occasion to return to basics, with strategies built around adding long-term value rather than exploiting leverage. Given drops in valuations, this year could turn out to be a good ‘vintage’ for new long-term property investments.
Asian assets Whipsaws in US bond yields over the past month have had their impact on assets outside the US, but the US dollar’s retreat and softening US yields, together with China’s re-opening, are seen as contributing to the performance of Asian equities, and especially growth-oriented equity indexes in north Asia (China, Korea, Taiwan). Yet the sluggish recovery of the Chinese property market and recent hints to investor sentiment have been showing up in Asian corporate bond indexes. While yields in high-yield Asian debt look juicy, we prefer Asian investment-grade debt (where we are overweight), which offers attractive risk-adjusted returns. As in the case of bonds, Chinese re-opening appeared to be doing little for Asian currencies until recently. And while an end to Fed rate rises should be good news for currencies in emerging Asia overall, an economic downturn in the US that spreads more globally could hinder the performance of cyclical Asian currencies.
Asset-class views and positioning
We were defensively positioned at the onset of the banking turbulence in March, with underweight positions in developed-market equities and high yield together with overweight positions in gold and US Treasuries. We maintain this defensive stance, and have made further efforts to ‘de-risk’ our positioning by moving to an underweight tactical position on global small-cap equities and REITS. We have also moved down a notch on hedge funds (to neutral), in consideration of the improved yields now available on liquid short-term bonds, for example. At the same time, our belief that Europe could skirt a recession this year and a more attractive equity-risk premium than in the US have been among the factors deciding us to move from an underweight to a neutral position on euro area equities. This matches our similarly neutral positions in Japanese, Asian (ex Japan) and large-cap UK equities. We have also switched to an overweight position on the euro versus the US dollar, reflecting a compression of interest-rate differentials.
Three investment themes
i. Revenge of the 60/40 portfolio. We believe that negative correlations between bonds and equities will progressively re-assert themselves and that government bonds are once again coming into their own, contributing to a comeback for 60/40 portfolios. We also believe quality investment-grade bonds of low duration have their place in diversified multi-asset portfolios.
ii. Favouring fixed-rate over floating-rate debt. Countries where variable-rate debt is prevalent are especially vulnerable to high or rising interest rates. Stress in markets where variable-rate mortgages dominate could expose government bonds and currencies to weakness at a time of high and rising rates. We likewise prefer fixed-rate corporate debt to floating-rate bond funds.
iii. 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.