House View, April 2022
Asset Allocation: We remain neutral on global equities overall but are prepared for new bouts of volatility and downward revisions to earnings. We are overweight the Japanese and Swiss equity markets – the former because it is cheap, the latter because it is full of the defensive growth companies we like. With margins under pressure, we continue to like the stocks of companies with adequate pricing power.
We have moved from underweight to neutral on US investment-grade credit (given relatively solid coverage ratios and good yields) but have moved underweight US high yield as funding costs increase. In general, we see opportunities in credit spreads.
We see good opportunities in the currencies of stable commodity-rich economies with hawkish central banks – in the first instance, this means the Norwegian krone and Canadian dollar.
Macroeconomy: Studies suggest global growth this year could drop a full percentage point if commodity prices remain at recent levels while global inflation will increase. This is placing monetary authorities in an acute dilemma.
Nevertheless, we believe the Fed could well hike rates by 50 bp at its May meeting, followed by two further 25 bps rises by July. We have slightly reduced our US GDP growth forecast for 2022 to 3.2% (from 3.4%) and raised our consumer inflation forecast to 6.6% (from 4.8%).
Some forward-looking surveys in Europe have weakened considerably of late, leading us to cut our euro area growth forecast this year to 2.8% from 4.9%. We have also reduced our forecast for the UK to 3.7% from 4.5%. Our central growth forecast for China is 4.5% (lower than the official growth target of 5.5%).
Commodities: Unsurprisingly, commodity prices remain volatile, with relatively limited capacity for other producers to take up the slack from declines in Russian energy exports. We expect further short-term spikes in oil prices before demand destruction brings Brent oil to about USD95 by year’s end. We are also monitoring the impact on food supplies of reduced Russian and Ukrainian wheat exports.
Currencies: The combination of supportive trade flows and attractive carry should help a number of relatively undervalued commodity currencies. The euro and the yen have both been languishing lately. Both are exposed to rising energy import costs. But along with any de-escalation of the Ukrainian conflict, ECB moves to normalise monetary policy later this year could boost the euro.
Equities: Earnings forecasts for major equity indexes have proven resilient so far, with the rise in commodity-connected sectors’ prospects compensating for downgrades elsewhere, including in consumer-facing sectors. Valuations have been declining, especially in Europe, so that US equities now command an even larger premium than before. High commodity prices are beginning to dent margins, particular in cyclical sectors.
While sanctions on Russia are having an impact on the production capacity of the car industry and other manufacturers, the current situation is also producing winners in the commodities and defence sectors. We also like the global pharmaceutical sector given the price insensitivity of its products while European capital-goods companies stand to benefit from accelerated investment plans for energy infrastructure and efficiency. With some exceptions, European banks’ direct exposure to Russia looks limited.
Fixed Income: Because we believe long-term US yields could fall back again in H2, we remain neutral on US Treasuries, seeing them as offering protection (although at a cost) in the event of economic slowdown. Increasing carry means we have moved from underweight to neutral on US investment-grade corporates, but to underweight on US high yield, which is more vulnerable to higher funding costs and the growth slowdown.
Asian Assets: We remain cautious on Chinese equities, despite recent promises of more stimulus, as household spending remains sluggish and the property sector still faces important issues. But we like Chinese sovereign bonds, which continue to offer positive real yields, and see potential in Asian investment-grade credits. Asian currencies remain vulnerable to geopolitics and we see scope for moderate devaluation of the Chinese renminbi in the months ahead.