Market and strategy update

What you need to know

• We expect global growth to continue to slow more than the market expects, but unevenly. As the euro area/UK fall into a deep recession, the US and China are still more resilient. 
• As central banks continue to tighten to tame inflation, risks of policy mistakes are elevated.  
• We believe the recession is not fully reflected in the prices of eurozone equities, which led us to predominantly reduce our equity exposure in this region recently.
• Instead, the uncertain environment supports the view to hold some USD cash in the near term, which we will look to deploy as opportunities arise.

Markets at a glance

Markets - Hard to follow

• After several reversals last week, major equity markets in the end finished lower overall: the MSCI All Country World index –1.9%, the S&P 500 index –1.5%, the MSCI Emerging Markets index -3.4%, the FTSE 100 -1.9%, but the STOXX 600 flat. Equity volatility, as measured by the VIX index, remains high at above 30%.
• Markets were particularly volatile in the hours following the publication of US inflation data (see below), which led to a sell-off in bonds while equities staged a strong rebound after initially plummeting, without any obvious reason, only to fade again on Friday.
• UK markets remain in the spotlight given the government’s twists and turns on the budget (see below). The Bank of England’s intervention (BoE) helped to limit the rise in UK government bond yields, while investors found solace in the likely U-turn on tax cuts. The gilts rally then faded as fiscal uncertainty remains, with the new Chancellor of the Exchequer failing to rule out more U-turns on the ‘mini budget’ (10-year yield to 4.33%). The pound was also volatile, closing slightly higher versus the dollar (+0.8%) although volatility will likely stay high until the publication of the fiscal plan and economic forecasts on 31 October.
• The euro remained under pressure (-0.8% week on week) given the recessionary outlook and a less hawkish European Central Bank vs the Fed. The dollar remained strong last week, with the Fed likely to remain hawkish given the recent inflation and labour data, which underpins our view for a strong USD in the near term.

Past performance is not a reliable indicator of future returns.

Central banks & inflation – Slow and uneven inflation decline

• Once again, US inflation surprised to the upside in September, falling from 8.3% previously to 8.2%, a smaller fall than expected (both year over year). More worrying was that core inflation accelerated to 6.6% (year over year), with shelter, food and medical expenses contributing strongly.
• Markets reacted to the US inflation data by pricing in an additional rate hike by the Fed, which brings the expected peak rate to around 4.9% by next spring, above the Fed’s guidance. We think that a 75 bps increase in November is still the most likely outcome, though chances of a slowdown in December have fallen somewhat (but remains our base case).
• The BoE broadened the scope of its emergency asset purchases by including inflation-linked gilts following a sharp rise in real yields. The bank did stick to its initial plan, however, by concluding purchases as of last Friday; we believe the bank of England will resume intervention should there be further signs of stress in the gilt market.

Economy – Unclear fiscal path in the UK; and EU discussing gas price limits

• The outlook for the UK remains uncertain and a lingering source of market volatility. PM Truss has replaced chancellor Kwarteng with Jeremy Hunt, with the market focused on potential additional U-turns on the budget. Such fiscal uncertainty is not welcome at a time when the UK is entering recession. Recent data confirmed activity is contracting (August industrial production -5.2% year over year and August GDP -0.3% month on month).
• The European Commission is expected to present a new package of emergency measures to curb energy prices on 18 October, although the 27 members still need to reach a consensus before anything is confirmed. The euro area saw its trade deficit widening to a record level of EUR50.9bn as imports soar on high energy prices.
• Given the ongoing tightening of the Fed, the US housing market is slowing down significantly with both new and existing home sales down ~20% in 2022 and housing affordability lower by ~30%.

What we are watching

• The congress of China’s Communist Party kicked off on 16 October and will last for seven days – developments related to XI Jinping’s potential succession, fiscal policy, zero-Covid (unlikely to be abandoned soon given Xi’s opening remarks) and long-term economic goals will be closely monitored. Meanwhile, the People’s Bank of China could cut rates (Thursday), given a tepid economic recovery - Chinese GDP (Tuesday) is estimated to have grown modestly in Q3 by 3.4% year-on-year.
• After a dip in August, US industrial production (Tuesday) is expected to have ticked up during September due to a modest improvement in manufacturing conditions, underscoring our view that the US economy is still relatively robust.
• German producer price inflation (Thursday) is estimated to have softened during September, but from an elevated level of 45.8% on a yearly basis – this is unlikely to ease inflation fears and supports additional ECB rate hikes.
• UK headline consumer price inflation (Wednesday) during September is projected by the market to have reached 10.1% on a yearly basis, mainly driven by an estimated 6.4% uptick in core inflation. The Bank of England will likely continue to raise interest rates, albeit not as much as what markets are pricing – we forecast a terminal rate of 4.75% in 2023 vs markets expectations of 5.3%.

Our views

Source: In-house research as at 17 October 2022. N= Neutral weighting of the asset class within the Strategic Asset Allocation.

• With global growth slowing and tail risks remaining elevated we recently reduced our overall equity allocation and increasing our cash holding while waiting for more attractive entry points in markets. In particular, we maintain a high conviction view that Eurozone equities will increasingly come under pressure as earnings begin to disappoint into Q4 and H1 2023.
• We believe the outlook for a hawkish Fed should be supportive of our preference for US dollars over both euro and sterling. Additionally, we believe the continued resilience of the US economy as evidenced by a strong labour market should favour the US rather than eurozone equities.
• We continue to closely monitor developments in Eastern Europe with respect to developments regarding Ukraine-Russia and the related energy implications.
• Policy uncertainty is keeping a grip on domestic UK assets which could face continued downward pressure or, at the very least, remain very volatile until the fiscal outlook becomes clearer. In our portfolios we maintain a low exposure to UK gilts and euro government bonds until rates volatility normalizes.
• Elsewhere, we do still see value in EM Sovereign USD bonds (hedged), however, as we believe the asset class has corrected too far for the current economic environment and thus offers the opportunity to outperform in the medium term.

Our Investment strategy

• As a result of our more cautious outlook for the economy and markets, we de-risked our model portfolios in early October. This follows changes implemented in July (reduction of eurozone equities) and early September (purchase of a defensive US equity manager).
• The recent move to increase the allocation to cash provides an additional defensive element to the portfolios whilst also increasing the flexibility to take advantage of volatility in markets at the appropriate time.
• The magnitude of the risk reduction may be perceived as marginal but this is intentional for a number of reasons; firstly, we believe the outlook for markets has worsened although we do not see it as very bleak either; secondly, markets are fast moving with a number of catalysts that could lead to a rebound. In particular, central banks could be moving closer to indicating the peak of the hiking cycle should they perceive demand is weakening and inflation is rolling over.
• As tempting as it may be to react to short-term market movements, we invest for the long term. Research suggests that where long term investment is suitable, the benefits of staying invested outweigh those of timing the market. Looking at the past century or so, cumulative stock returns in the US have been more than twice as high when staying fully invested compared to if one had missed the 10 best trading days in each decade.
• Overall, we maintain composure and conviction in the key pillars of our Portfolio Strategy: 1) Globally diversified asset allocation, 2) Quality growth-biased equity allocation, 3) Increasing sustainable investment strategy.

Market performance








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Information correct as at 17 October 2022.

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