House View, September 2022
Asset class convictions. We have raised our overall tactical position on fixed income to neutral. The rise in the yield offered by safe-have government bonds at a time of growing economic stress and a possible downturn in inflation is increasing their attractiveness. At the same time, we have lowered our stance on equities by one notch across the board. We are now underweight developed- and emerging-market equities in general. While the asset class still looks attractive in the long turn, we have moved tactically from overweight to neutral on private equity.
Investment themes for the rest of 2022. A number of the themes we developed at the start of the year have been showing their worth. For one, the ‘It ain’t over ‘til it’s over’ theme has ensured we stick to an active tactical approach to fast-changing market circumstance, while the ‘pricing power’ theme continues to draw us to companies to companies with consistent dividends and the ability to maintain stable earnings. The present dislocations justify our continued interest in global macro hedge fund strategies. The ‘Who pays the bills?’ theme has gained in salience as energy costs rocket, and underpin our decision to treat volatility as an asset class in its own right. Another theme, ‘the slow unbundling’ refers to the growing divergence in countries’ approach to the present crises and allows us to be upbeat on investment-grade Asian credits in hard currency.
Macroeconomy. We have decided to lower our forecast for world GDP growth to 2.9% this year (from a previous estimate of 3.3%) and to 2.7% in 2023 (compared to 3.0%), with the downturn in business activity also likely to lessen inflationary pressure. Outside European gas, commodity prices are likely to remain on the soft side, leading us to lower our year-end forecast for Brent oil from USD110 to about USD100.
We continue to expect a mild US recession toward the turn of the year and we now expect real GDP growth of -0.8% in 2023 compared with 1.3% in 2022. As long as employment gains slow and inflation continues to come off the boil, we believe the Fed will stop raising policy rates when the Fed funds rate reaches 3-3.25%.
We believe GDP in the euro area will decline from 2.9% this year to zero in 2023. Faced with persistent inflation and a faltering economy, policy normalisation by the European Central Bank will be complicated, although it will have to act fast to tackle high inflation (we believe headline inflation could hit 10% in the coming months).
We continue to forecast full-year GDP growth of 3.2% in China this year. While we could have important news on economic strategy emerge from the communist party congress next month, we believe policy support insufficient to fully offset the short-term pressures weighing on the Chinese economy. We expect Japan’s moderate recovery to continue (our GDP forecast for this year is 1.5%). Relatively weak inflation means the Bank of Japan could try to stick with ultra-dovish monetary policy, but severe yen weakness is testing the Bank’s yield-curve control.
Currencies. It is hard to see scope for a sharp depreciation of the US dollar against currencies like the euro or the Chinese renminbi in the short term. But we are not overly positive on the US dollar, believing that a downturn in US growth and inflation could narrow the interest rate differential, especially against the euro, as we move into 2023.
Equities. We have lowered our year-end price targets and moved to an underweight position on developed-market equities overall as concerns about valuations and future earnings grow. But their defensive tilt allows us to be neutral on Swiss equities. We are also neutral Japanese equities due to their diversification benefits and the UK market due to its commodities exposure. Sector wise, we remain upbeat on the energy sector, expecting strong shareholder payouts to continue. We are also reasonably confident that tech mega caps are well equipped to withstand margin pressure. As in developed markets, we have moved to an underweight position in emerging-market equities as earnings prospects erode.
Fixed income. We are sticking with a year-end forecast of a 10-year US Treasury yield of 2.6% and 10-year German Bund of 1.3%, believing that the market has gotten ahead of itself in terms of rate forecasts as the world faces into a downturn. Alongside safe-haven government bonds that we see gaining in attractiveness, we are underweight euro area peripheral bonds as well as UK gilts, which is facing particularly high inflationary pressure. With funding conditions deteriorated, we are also underweight high-yield credits, seeing their investment-grade peers as a safer source of carry.