Premature Green Shoots?
This note contains a section on recent developments, our views, what we are watching, and our portfolio strategy. These developments may not mean changes to your portfolio so please contact your adviser for the latest update on your portfolio. Comments on recent performance are not indicative of future performance.
What you need to know
- Excessive risk taking in portfolios remains premature in our view. Our strategy remains focused on backing asset classes where we have conviction, whilst avoiding those carrying greater risks.
- Falling inflation prints are welcome, but they also signal that the economy is slowing. We continue to expect global growth to slow more than the market expects, albeit asynchronously.
- We believe markets are likely to remain volatile as central banks retain their data-dependent and meeting-by-meeting approach. With central banks continuing to tighten and raise rates, the risks of policy mistakes remain high.
- Absent any major market developments, our next communication will discuss our outlook for 2023. Stay tuned.
Markets at a glance
Markets – Rally in doubt
- Markets remained somewhat volatile last week although overall returns from equities and bonds were broadly flat.
- Risk assets took a breather mid-week, following comments from a senior US central banker that US rates may have to rise above the level currently priced in by markets.
- US equities closed marginally lower (S&P 500 -0.7 %) whilst European markets rose slightly (STOXX 600 + 0.25 %). Chinese stocks finished the week in positive territory (CSI 300 +0.4 %) despite a rise in Covid cases in the country that may end up slowing the relaxation of restrictions. This morning, however, Chinese equities came under pressure again, following reports of Covid-related deaths.
- The mixed sentiment in markets helped support the US dollar (US dollar index + 0.6%), despite US bond yields falling.
Central banks & inflation – Inflation slows in US but rises in UK and EU
- Comments from a range of US central bank speakers confirm what we have expected for a while: more interest rate hikes are coming, but a smaller 0.5% increase in December looks likely as slowing US producer price inflation (to 8% from 8.5% previously) hints at declining pipeline pressures.
- Pressure remains on the European Central Bank to raise rates after inflation in the euro area surprised to the upside in October. Inflation surged to 10.6% from 9.9%, with core inflation also retaining its upward momentum
- UK consumer prices rose 11.1% in October (year-on-year), well above consensus and the Bank of England’s (BoE) own projections. Energy and food contributed strongly, though favourable base effects may help the headline measure peak in the near-term. The BoE is expected to raise rates to between 4.5% and 4.75% by H2 2023.
- Comments from a range of US central bank speakers confirm what we have expected for a while: more interest rate hikes are coming, but a smaller 0.5% increase in December looks likely as slowing US producer price inflation (to 8% from 8.5% previously) hints at declining pipeline pressures.
- Pressure remains on the European Central Bank to raise rates after inflation in the euro area surprised to the upside in October. Inflation surged to 10.6% from 9.9%, with core inflation also retaining its upward momentum
- UK consumer prices rose 11.1% in October (year-on-year), well above consensus and the Bank of England’s (BoE) own projections. Energy and food contributed strongly, though favourable base effects may help the headline measure peak in the near-term. The BoE is expected to raise rates to between 4.5% and 4.75% by H2 2023.
Economy – US activity resilient, mixed reopening signals from China
- In the US, industrial production was almost unchanged in October, although retail sales rose more than expected at 1.3% compared to the previous month. Housing data moderated further.
- The UK’s Autumn Budget mapped out a plan to cut spending and increase taxes by GBP 55 billion (about 2.5% of GDP - gross domestic product) helping to ensure the sustainability of the country’s finances.
- The UK economy contracted by 0.2% in Q3 compared to the previous quarter – as a result, the country’s fiscal watchdog is saying that the UK is already in recession, projecting a 1.4% contraction in 2023. Separately, UK retail sales in October fell 6.1% year on year although the GfK’s survey of consumer confidence showed a slight improvement.
- Eurozone GDP rose 0.2% compared to the previous quarter and in line with consensus estimates. German ZEW economic expectations in November recovered slightly, although they remain at depressed levels. Most leading indicators point to a recession in the near term, however.
- In China, a batch of October data (e.g. retail sales contracting 0.5% year on year) pointed to a broad-based economic weakening as the country remains restricted by repeated lockdowns. Reopening signals remain mixed as Covid cases surge in some cities. China’s reopening is unlikely to happen in a straight line and indeed may not happen until spring 2023.
- President Xi Jinping’s meeting with US President Joe Biden at the G20 summit helped ease concerns over the state of relations between the two countries. The two leaders agreed to improve communications going forward, beginning with a visit to China by US Secretary of State Antony Blinken early next year.
What we are watching
- The purchasing manager indices (Wednesday) are likely to reaffirm growth concerns for the euro area and corroborate the narrative that the UK is already in a recession, with both indices estimated to remain below the 50 watermark level – indicating economic contraction.
- Germany’s producer price inflation (Monday) is forecast to be 41.5% higher in October (year on year). Inflation worries likely further weighed on the German Ifo business climate (Thursday) and the GfK consumer sentiment survey (Friday). German GDP for Q3 (Friday) is expected to rise by 0.3% compared to the previous quarter.
- The Fed minutes (Wednesday) could give further guidance on the US hiking cycle, given the country’s lower than expected consumer price inflation print for October.
Our views
- The macro backdrop remains uncertain: we expect to see a recession in both the EU and UK given the headwinds faced by both regions caused by the gas/energy crisis. In the US, we see inflation peaking, although this is not the case in the EU/UK. More broadly, financial conditions continue to tighten.
- As we believe that a recession is not fully reflected in the prices of eurozone equities, we keep our reduced equity exposure to the region, while maintaining a defensive USD cash position for now.
- Within equities, we instead maintain our positive view on the high-quality US equity market, which we expect to outperform eurozone equities as earnings there remain too optimistic in our view. We also maintain our positive view of Emerging Market (EM) equities, based on attractive valuations for the region.
- Within bonds, whilst we are neutrally positioned overall, we maintain a preference for EM hard currency versus EU and UK government bonds.
- We see a number of catalysts for EM assets on the horizon; 1) EM central banks are possibly close to, or at, the end of their tightening cycle, and 2) China possibly reopening should be a notable positive.
- Looking forward, we continue to review the macro and investment landscape for opportunities to deploy cash in portfolios.
- 2022 has seen a wide dispersion between asset prices at the asset class, country and sector level and as such we are evaluating a number of opportunities among these both within equities and fixed income.
Investment strategy
- As 2022 comes to a close, we reflect on what has been an extraordinary year with a confluence of headwinds spanning geopolitical tensions to sharp interest rises and economic uncertainty.
- We are conscious that for many investors 2022 has been undoubtedly painful and we share the disappointment. However, we are not standing still and continue to steer portfolios towards asset classes where we have conviction whilst avoiding those carrying greater risks. We remain confident that this strategy will yield better results in the near future.
- For context, for fixed-income investors in particular, 2022 is on track to being the worst year ever. For equity investors, it has not been that unusual as equities have fallen by at least 15% in 8 of the past 20 years. For multi-asset investors, it has been challenging as fixed income failed to serve its traditional role of diversification.
- Looking ahead, the upshot is that from here on, with cheaper equity prices and higher interest rates, we believe future returns for both equities and fixed income should be higher.
- Once markets have sufficient reasons to look past near-term uncertainties, subsequent rebounds in performance could be sharp as investors move to discount the long-term (5 years+). We think the future remains bright, underpinned by a confluence of innovations across the economy, including energy, transportation, manufacturing and services, supported by artificial intelligence and robotics.
- Overall, we believe our strategy carries notable recovery potential, supported by our key pillars:
1) a globally diversified asset allocation seeking a broad spread of return and risk sources
2) quality growth-biased equity investments boasting strong balance sheets, high competitive advantages, high margins and high returns on investments
3) increasingly sustainable investments contributing to making the world a better place from an environmental, social and governance standpoint.
Market Performance
Past performance is not a reliable indicator of future returns.
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Investment Risk
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Information correct as at 21 November 2022.
Past performance is not a reliable indicator of future returns
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