What you need to know
- We expect global growth to continue to slow more than the market expects, albeit unevenly. Whilst the euro area/UK are likely to fall into a deep recession, the US and China remain more resilient.
- With central banks continuing to raise rates, it’s likely the risks of policy mistakes remain elevated.
- We believe that a recession is not fully reflected in the valuation of eurozone equities - this led us to recently reduce our equity exposure to the region.
- The uncertain environment supports our view to hold some USD cash in the near term, which we will look to deploy as opportunities present themselves.
Markets at a glance
Markets – Buying the rumour
- US equities underperformed over the week following the increase in interest rates and the US Central Bank’s (Fed’s) accompanying statement that hinted that rate rises would not slow as much as the market was hoping. The S&P 500 lost 3.3% bringing down the MSCI World index (-3.6%), whilst European equities continued to rebound, with the STOXX 600 gaining 1.5%. Finally, the FTSE 100 post gains (+4.1%) following the Bank of England’s dovish message regarding the path of interest rates going forward.
- The potential relaxation of China’s zero-Covid policy also fuelled a rally in battered Chinese equities; the Shanghai Shenzhen CSI 300 rose 6.8%. Emerging market equities more broadly rose, with the MSCI Emerging Market Index finishing the week up 4.7%
- US Treasury yields rose with Fed Chair Powell’s statement (see above) leading to a repricing of the terminal rate (+45bps to a range of 5.25-5.5%). European government bonds sold off on Lagarde’s comments, whilst UK gilts rallied on slowing rate hike expectations.
- Overall, monetary policy developments drove the USD higher (DXY +0.2%), whilst the EUR and GBP ended lower over the week (-0.1% and 2.1% respectively).
Past performance is not a reliable indicator of future returns.
Central banks & inflation – Hawkish Powell, dovish Bailey
- The US Fed raised interest rates by 75 bps to a range of 3.75-4%. The accompanying statement from Fed Chair Powell, whilst attempting to manage expectations that the bank may slow the pace of hiking (but not pause it), also acknowledged that the terminal rate could be higher than previously anticipated.
- The Bank of England proceeded with its largest rate increase since 1989 (+75 bps), bringing the Bank base rate to 3% but with fewer hikes now expected as Britain appears to be heading for a deep recession.
- European Central Bank’s Lagarde said interest rates could rise further even if growth contracts to limit excessive dovish market expectations, which would work against tightening financial conditions.
Economy – Resilient US labour market; growth concerns in the euro area
- The US jobs market added 261,000 jobs in October (vs 263,000 in September), above consensus of 200,000 new jobs, with wages growing 0.4% compared to the previous month. However, the unemployment rate ticked higher to 3.7% (3.6% in September) with 306,000 new unemployed workers, the second largest increase since the start of the pandemic.
- Sluggish economic growth of 0.2% compared to the previous quarter in the euro area (vs 0.8% in Q2) kept recession fears elevated. Inflation rose further to 10.7% year over year in October – core inflation (which exclude food and energy) grew by 5%. Finally, the unemployment rate for the euro area matched consensus falling to 6.6% (vs 6.7% in August).
- Speculation that the Chinese government is increasingly likely to relax its zero-Covid strategy continues, although any changes will be dependent on the spread of the virus and effectiveness of the country’s new inhaled vaccines.
What we are watching
- The US 2022 midterm elections (Tuesday) will see all 435 US House seats and 35 out of 100 US Senate seats up for grabs. Against the elevated inflation backdrop, the Republicans could capitalise and gain a majority in both the House (where the Democrats currently have slim control) and the Senate.
- US consumer price inflation in October (Thursday) is expected to stay elevated at 8% year on year, primarily driven by renewed increase in energy prices and persistent food price pressures – core inflation is estimated to stay at 6.6%, with stubbornly high rents.
- UK Q3 GDP (Friday) is estimated to have contracted by 0.2% relative to the previous quarter and compared to growth of 0.2% in Q2. The recent slump in UK manufacturing purchasing managers’ index and the significant drop in retail sales suggest that the UK economy is already contracting.
Our views
- With global economic growth expected to slow further and uncertainty remaining elevated we reduced in early October our overall equity allocation in favour of US dollar cash. This positioning is unchanged.
- At this point, our research continues to find investment opportunities within asset classes as the valuations of a number of regions have come down markedly this year.
- Within equities, for instance, we are overweight US equities over Eurozone equities, the latter which will in our view increasingly come under pressure as company earnings begin to disappoint. We also continue to closely monitor several sectors where we see a mismatch emerging between share prices and long-term fundamentals.
- On the fixed income front, monetary policy remains a key determinant of our near-term outlook. The prospect of the Fed shifting to a 50 bps hike in December, our base case, is not a done deal given strong wage growth and elevated inflation. Such dynamics also mean that, further down the road, a decisive dovish pivot may come later than initially expected, e.g. in Q2 rather than Q1 2023.
- Although bond yields have risen a lot this year, we do not think now is the time to add to fixed income yet. We find value within the asset class in Emerging Markets Sovereign USD bonds (hedged), 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.
- On the currency front, the US Fed remains the most determined central bank in combating inflation, which supports our overweight of US dollars over both euro and sterling.
Investment strategy
- Our investment strategy incorporates the above views with the increased allocation to cash adding flexibility and some defensiveness to portfolios.
- Overall, we maintain conviction in the key pillars of our Portfolio Strategy: 1) Globally diversified asset allocation, 2) Quality growth-biased equity allocation, 3) Increasingly sustainable investment strategy.
- Even though a number of pillars of the strategy have been challenged this year in terms of performance, we constantly review their long-term merits as we seek to enhance outcomes and improve the investor journey.
- We, for instance, are currently seeking investment opportunities with good asymmetry, in other words those with possible limited near-term downside and solid long-term upside potential.
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Information correct as at 07 November 2022.
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