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. Comments on recent performance are not indicative of future performance.
What you need to know
- Despite the market optimism since the start of the year, we are maintaining our slight risk-off stance in the near-term with a preference for higher quality assets with more defensive characteristics.
- As government yields remain attractive, we are taking the opportunity to reduce risk within fixed income by reducing the emerging market debt exposure into safer developed market government bonds.
- Central Banks reconvene this week with expectations that the Fed will likely return to a normal 25 bps hike, whereas both the ECB and the BoE are expected to lift rates by 50 bps.
- Last week, US equities outperformed the euro area, which has been positive for portfolios given our preference for the quality US market. This has helped portfolios post positive returns this year, with our exposure to quality-oriented investments a further tailwind.
Past performance is not a reliable indicator of future returns.
What’s changing in portfolios?
- Continuing with our theme that 2023 is the year that bonds make a comeback in portfolios, we look to take advantage of the valuation resets experienced in 2022.We continue to shift our fixed
- income allocations away from higher risk emerging market (EM) bonds – both local and corporate – towards government bonds as they are now finally providing decent yields and lower risk characteristics.
- Unlike in previous years, higher bond yields mean that bonds are better placed to provide diversification benefits and even if bond yields were to edge higher, the current level of yields provides a certain cushion.
- While some downside risks to markets have eased, they haven’t disappeared. Most notably, we believe euro area equities are yet to suitably adjust to the deteriorating economic conditions and are currently pricing too optimistic an outcome. We instead maintain a small allocation to US Treasuries and focus on emerging market equities and hard currency sovereign bonds, where we believe the reopening in China will be more impactful.
Markets at a glance
Central Banks & Inflation – Size matters
- The Fed, the ECB and the BoE reconvene on Wednesday / Thursday. The Fed will likely return to a normal 25 bps hike, whereas both the ECB and the BoE are expected to lift rates by 50 bps.
- The Fed slowing further the pace of hiking – and any change to forward guidance – will likely soothe markets. In contrast, the ECB’s 50 bps hike could be a source of concern as inflation looks like it has already marked a peak in October 2022.
- The UK has not significantly moved past the inflation peak, but a 50 bps hike could nonetheless spook markets given recent evidence of a growth slowdown.
- Overall, we expect central banks to stop raising interest rates in the coming months as efforts to slow inflation and the economy have been paying off.
Markets – Positive market mood remains
- Equities continue to outperform bonds in 2023. Most notably, US equities have outperformed the euro area last week, on more signs inflation is cooling, led by a resurgent technology sector.
- Meanwhile, major currencies and government bonds have recently traded sideways, perhaps awaiting more clarity surrounding central bank intervention.
Economy – A soft landing still on the cards
- The recent upside surprises in US economic data make a soft landing in the US still possible.
- Although it seems the euro area could dodge a deep recession given the milder winter experienced, we maintain a cautious view toward European equities due to what we believe remain unrealistic earnings expectations. In this regard, we keep a close eye on the ongoing earnings season in Europe.
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Information correct as at 31 January 2023.
Past performance is not a reliable indicator of future returns
© Brown Shipley 2023 reproduction strictly prohibited.
Past performance is not a reliable indicator of future returns.