In this note, we provide you with an update on significant recent developments and our views. 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
– European jitters
- Equity markets remained under pressure last week with equities falling across the globe and bond yields rising, although the US dollar retreated from its recent highs, with the US dollar closing 0.9% lower mostly on broad quarter-end rebalancing flows.
- The MSCI All Country World index closed 2.6% lower. Developed markets and emerging markets alike fell; the MSCI World index lost 2.5% and the MSCI Emerging Markets fell 3.6%. Equity market volatility, as measured by the VIX index, has risen above its yearly average at around 30%.
- The focus was still on UK markets following the ‘mini budget’ release. The FTSE 100 index lost 1.8% and the 10-year gilt rose ‘only’ 30 bps after rising as much as 80 bps. The Bank of England intervened in the fixed income market buying GBP 65 bn worth of government bonds to avoid a meltdown in the bond market, which is key for pension funds. The BoE’s intervention, and earlier this week the policy U-turn on income tax cuts, helped the pound recover above USD 1.10/GBP.
- What happened in the UK also tells us that risk of fiscal slippage is a threat, in Italy most notably. The BTP-Bund spread has already widened close to crisis levels (pandemic, trade war) at ~240 bps.
- We expect market volatility to stay high, including currency volatility, amid a deteriorating macroeconomic backdrop. The balance of risk remains skewed towards USD strength in the near term, propelled by a Fed in overdrive for the next couple of quarters and a wide range of uncertainty (rising recession risks, an escalation in the war in Ukraine and risks of policy mistakes/policy volatility).
- A strong USD also means that risk assets may continue to face downward pressure, with most equity indices already drifting below June lows. A true circuit-breaker though would be a change in the Fed’s rhetoric, but recent communication and data suggest this is not for now.
Comments on recent performance are not indicative of future performance
Central banks & inflation
– Keeping the hiking pace
- Following an unprecedented sell-off in the gilt market, the Bank of England announced temporary purchases of long-dated gilts to safe-guard market stability. Active bond sales – scheduled to begin on 1 October – were delayed until the end of the month.
- Several European Central Bank speakers have spoken out in favour of a 75 bps increase at the central bank’s next meeting at the end of October, in line with market pricing and our own view. Sustained inflationary pressures in September, particularly from energy prices, should provide rationale for such a move.
- The Fed is on track for a fourth consecutive 75 bps rate increase in November following a string of robust economic data, particularly from the labour market where falling jobless claims signal ongoing tightness.
- The eurozone’s preliminary inflation rate for September jumped more than expected from 9.1% in August to 10.0% (vs 9.7% consensus). It remained mainly driven by energy (+40.8% year on year) as well as food (+11.8%). However, core inflation also increased by 0.5 percentage points to 4.8%, as both services and industrial goods prices showed rising growth dynamics, with the end of German public transport and petrol subsidies as of end-August also contributing to the increase.
– Eurozone running with double-digit inflation into recession
The week ahead
- In light of the ongoing European energy crisis, with Russia annexing four eastern Ukrainian provinces, Germany announced an up to EUR 200bn defence shield mainly to cap gas prices against the consequences of the war, completely financed by new debt. This could soften the country’s further inflation trend at least a bit.
- In the UK, Chancellor of the Exchequer Kwasi Kwarteng eventually ditched plans to cut income tax for the highest earners following a political backlash, which had caused turmoil in domestic financial market due to concerns over the government's fiscal credibility. Market volatility could however remain elevated given the ongoing political uncertainty.
- In the US, consumer confidence in September improved versus consensus, consistent with most other data that the economy remains more resilient than Europe.
- While in September China’s manufacturing PMI unexpectedly picked up slightly from 49.4 to 50.1, the non-manufacturing PMI fell to 50.6 from 52.6 in light of still ongoing Covid flare-ups – underpinning a moderate growth trend in China.
Tactical asset allocation
- US labour market is projected to continue to demonstrate strength in September’s US jobs report (Friday), with the unemployment rate likely to stay low at 3.7%.
- The ISM purchasing managers’ index for US non-manufacturing (Wednesday) sectors is expected to remain above the 50-watermark level (the ISM manufacturing released on Monday fell but remained above 50), supported by strong consumer demand and business activities.
- The Reserve Bank of New Zealand (Wednesday) is anticipated to conduct a 50bps rate hike to 3.5%, although the Reserve Bank of Australia only lifted its policy rate by 25 bps.
- In light of the recent escalation in geopolitical tensions alongside the continued hawkish rhetoric from developed market central banks, we have increased our probabilities of recession globally. In particular, we now see the probability of an economic and earnings recession in Europe as highly likely.
- With this updated view in mind, we have reduced the risk levels in portfolios by decreasing the exposure to equities, in particular Eurozone equities, and instead increased the cash weighting, with dedicated exposure to US dollars.
- Our reduction of Eurozone equities is driven by the belief that both earnings and valuations are yet to adjust to the risk of considerable slowdown in growth across the region.
- While the market remains uncertain, our tactical USD cash exposure aims to provide an opportunity to be more dynamic in allocating capital should the right catalysts emerge.
- The result of the above is to effect a further risk reduction following the changes that were implemented in July and in early September. These changes have helped portfolio performance during the recent sell off.
- We continue to review and monitor our other positions in the portfolios in light of current conditions, but as of now remain comfortable that these holdings continue to diversify each other, providing different sources of risk and return for the portfolios.
- 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 vehicles.
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Information correct as at 05 October 2022.
Past performance is not a reliable indicator of future returns
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