House View, November 2022
Despite the October rally, we remain underweight equities in general for now as we believe that earnings expectations are still too optimistic and that earnings and sales will be challenged particularly hard this quarter. There are exceptions; we are neutral the defensive Swiss equity market, for example. We are overweight liquidity and are paying special heed to cash management. In fixed income, we remain neutral on US Treasuries and core euro area government bonds, finding opportunities in relatively short duration debt. While underweight high-yield corporate bonds, we are neutral US investment-grade (IG) equivalents and overweight hard-currency Asian IG bonds. We are also overweight hedge funds.
Sea-freight rates have been falling rapidly as bottlenecks are resolved, while there are signs of a drop in the producer prices in some places that could start to feed into global consumer inflation. The challenges to demand and favourable base effects could bring inflation rates back closer to their long-term trend at some stage.
The outlook for US growth has been darkening, even as the Fed continues to combat high inflation through hefty rate hikes. The property sector is the main risk to the US’ s economic prospects. Even as the risk of recession looms closer, there is a strong risk the midterm elections result in policy gridlock.
Economic indicators across the euro area point to a decline in economic activity in the months to come. While headline inflation remains in the double digits, one positive development has been the drop in gas purchases. The ECB hiked rates by 75 bps on 27 October, but nuanced its message about future rate rises, adopting a more data-dependent approach. We think the next rate hike (in December) will be 50 bps.
The presentation of a new mid-term fiscal plan in mid-November is set to underline the challenges of trying to restore fiscal credibility while avoiding the impact of further austerity on an already fragile UK economy. Meanwhile, inflation of over 10% is keeping pressure on the Bank of England.
GDP growth of 3.9% in Q3 was ahead of expectations, helped by industrial production. But there has been only limited improvement in household spending and the property sector remains stressed. As Xi Jinping consolidates even more power, there has been little sign of a let-up in zero-covid policies, which have been hindering prospects.
We expect Japan’s moderate recovery to continue, with the country on course to achieve 1.5% this year and 1.3% in 2023. We also expect the Bank of Japan to continue with yield-curve control for the time being despite significant weakening of the yen.
Equity markets rebounded in October, although some high-profile high-related names produced ugly numbers and provided downbeat guidance. The margin pressure that some of these tech names are under because of their exposure to discretionary consumer spending is helping to justify our underweight stance on US equities. (And since earnings forecasts have only just started in Europe, we are underweight euro area equities too.) But one should not tar all tech-related stocks with the same brush; there are also well-established, highly profitable, cash-rich companies in the sector with plenty of pricing power. In emerging markets, Brazilian equities have been rebounding because of political developments. By contrast, political developments have bedevilled Chinese equities recently.
Uncertainty about inflation and monetary policy continues to cause volatility in bond markets while central banks’ intent on reducing their balance sheets and growing capital restraints on commercial banks is sapping liquidity from the market. In the circumstances, while we are attracted by the higher yields now being offered and are now neutral US and German debt, we are underweight euro periphery and UK government bonds.
Amid much bond-market volatility, corporate bonds have proved surprising resilient in recent weeks, with credit indexes outperforming government-bond equivalents. In addition, there has been only a slight increase in default rates so far. Nevertheless, the risk that default rates rise more substantially as recession nears means we continue to prefer ‘safe’ carry in short-to-medium-term investment-grade credits.
Sterling rebounded though much of October after unfunded spending plans were shelved. It remains to be seen how far the sterling rebound can last as further spending austerity will further hurt a weak economy and the Bank of England may disappoint market expectations for rate hikes.
Volatility, especially in fixed-income and currency markets, has been providing rich pickings for certain hedge-fund strategies, including global macro strategies that trade on dispersions in the performance of asset classes worldwide. Market misprising are also helping relative-value and event-driven strategies.