In this note, we provide you with an update on significant recent developments and our views. Comments on recent performance are not indicative of future performance. As our investment strategy and views are defined with a long-term horizon in mind, these developments may not mean changes to your portfolio. Please contact your advisor for the latest update on your portfolio.
Markets at a glance
– Equity recovery faces steadfast Fed
Central banks & inflation
- Following a strong bounce-back in July, equities continued to rally in August, until comments from Fed Chair Powell prompted an about-face. The S&P 500 fell 1.67%* and the Nasdaq declined 2.65%*. A darkening growth outlook for Europe saw the Stoxx 600 lose 2.78%*, while the FTSE 100 was roughly flat (at 26.08.2022).
- In a repeat of last month, Gilts led losses in sovereign bonds, with the yield on 2-year bonds rising more than 100 bps (to 2.78%), reflecting rising inflation pressures and a stronger than expected response from the Bank of England. Yields on short-dated German government bonds (+70 bps) and US Treasuries (+48 bps) rose less. Typically, long term interest rates are higher than short term rates, however the US yield curve remains deeply inverted, with shorter rates remaining higher than longer rates.
- Gold lost 1.6% this month, as rising real yields and ongoing strength in the dollar (+2.7%) outweighed safe-haven demand in the face of rising geopolitical tensions.
- Fed pivot still some way off, UK energy bills set to rise sharply
- Chair Powell’s speech at the Fed’s Jackson Hole symposium last Friday signalled they remained committed to raising interest rates, triggering a broad equity market selloff. He reiterated that it will become appropriate to slow the pace of US interest rate hikes at some point, but not just yet as progress on inflation “falls far short of what they will need to see before they are confident that inflation is moving down”.
- On developed markets, we expect inflation to be a particularly difficult problem to tackle especially in the UK, where a typical gas and electricity bill will rise to £3,549 a year from October (+80%), following an increase in the energy price cap.
- US slowdown, European recession
The week ahead
- The latest Purchasing Managers’ Index (PMI) from across the globe showed disappointing figures, with the US composite index falling to its lowest since February 2021. In the euro area, the PMI index fell further, potentially indicating that the region is contracting, with Germany underperforming the other large economies in the zone. The UK composite PMI index slowed to 50.9 from 52.1 previously, remaining just about above the 50 line that separates expansion from recession.
- Our analysis shows that Germany is most likely falling into recession. Following major declines in the last few months, the Ifo business climate (an indicator of economic activity in Germany) weakened further in August, although not as much as feared. The headline index stands significantly below its long-term average whilst the expectations component looks particularly grim and suggests extra weakness ahead.
- Evidence that US inflation is peaking got a boost from the latest personal consumption expenditures (PCE) report. Core PCE inflation (ex food and energy), declined 20 bps to 4.6% in July, while the overall inflation number dropped 50 bps to 6.3%. While these numbers remain high and should reinforce the Federal Reserve’s view that interest rates need to continue their upward path, they also support the notion that the Fed could slow the pace of tightening this autumn.
Tactical asset allocation
- Russia will shut down the Nord Stream 1 pipeline (Wednesday to Friday), raising the risk that gas flows will not resume thereafter. This is a key driver of our European recession call.
- Euro area inflation for August (Wednesday) is expected to have risen to 9% year-on-year, with a peak in inflation not expected until later this year at the earliest.
- China’s manufacturing sector is expected to remain in contraction, with the PMI (Wednesday) likely to show a small improvement to 49.2 from 49 previously. Conversely, the ISM survey (Thursday) should reveal that the US manufacturing sector continues to expand, though at a slower pace.
- US non-farm payrolls (Friday) will be key for the Fed’s next moves. Whilst consensus expectation of 290,000 jobs is far below last month’s blowout, it is still likely to be strong enough not to change the Fed’s view that interest rates still need to move higher from here.
- We recently reduced our equity position to neutral – in other words to its long-term strategic position – to reflect the uncertainty around the outlook for equity markets and more favourable bond yields. The more cautious stance is warranted at a time where we see macro cross currents (growth vs. inflation) and lack of clear direction in financial markets.
- In such a highly uncertain environment, we continue to focus on exploiting opportunities selectively within asset classes ahead of a clear trend emerging.
- We are overweight US equities and emerging market (EM) equities compared to eurozone equities. Elsewhere, we remain overweight EM sovereign bonds (USD-denominated) vs developed market (UK and EU) government bonds given the attractive yields of EM sovereign bonds, which we think will compensate the additional risk factor.
Past performance is not a reliable indicator of future returns.
- A strong first half of the month in August looks to be giving way to some weakness in markets as we move towards the autumn, although markets do remain above their June lows.
- As stated above, we keep our overall equity and bond weights neutral and in line with what we view to be the best long-run allocation.
- Within equities, the US element is based on our view that this high-quality market will outperform as growth uncertainty continues to rise. More specifically, when compared with eurozone equities, we note that historical analysis shows that US equities have tended to strongly outperform the euro area when growth slows, although this is not guaranteed.
- With regards to emerging market equities, we remain positive on the asset class given its deep discount both relative to global equities and its own history
- Within bonds we remain overweight emerging market hard currency sovereigns versus lower yielding government bonds.
* The previous edition (16/8/2022) of this publication contained incorrect P/E ratio data – the numbers were shown as percentages. The correct figures should be multiplied by a factor of 100 (eg 0.15 becomes 15, etc). Secondly, the performance data for GBP EUR and GBP USD had been transposed, ie GBP EUR data was displayed for GBP USD and vice versa. We apologise for any inconvenience that may have been caused.
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Information correct as at 30 August 2022.
Past performance is not a reliable indicator of future returns
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