Monthly house view | July 2023

Macroeconomy

There remains a divergence between relatively buoyant business surveys in emerging markets (outside China) and surveys showing manufacturing in contraction in advanced economies. Commodities demand paint a similar picture. We believe this divergence could last for a while yet as tighter financial conditions start to bite in advanced economies. While the US economy has proved more resilient than expected, we believe a shallow recession is on the horizon, possibly peaking at the turn of the year. Although inflation is slowing, we expect one last rate hike this month from the Fed, with policy rates on hold thereafter for the rest of the year. In the euro area, we also expect a 25 bp rate rise from the ECB this month, with possibly a final 25 bp rate hike in September. We expect the euro area economy to stagnate in H2 due to the lagged impact of previous rate increases. While we also expect the Swiss National Bank to raise rates in September, we believe Switzerland will achieve 1% GDP growth this year. In Asia, we believe further much-needed stimulus could stabilise growth momentum. In China We are therefore leaving our GDP growth forecast for China this year unchanged at 5.5%. Our growth forecast for Japan also remains unchanged (1.3% in 2023). We believe the Bank of Japan will stick to its very accommodative policy stance, although it could tweak yield-curve control. Economy momentum remains mixed in the rest of Asia, although we expect India to register strong 6% growth this year. 

Asset classes

Equities A resilient economy that has so far avoided recession and the boom in AI have been helping US equities, although the upcoming Q2 earnings season is expected to be the weakest this year outside tech. Given the strong earnings momentum in tech, we have upgraded our year-end target for the S&P 500—but we remain underweight US equities overall given valuation concerns and our view that other places offer greater potential. Sector wise, we believe that destocking and declining producer prices could put pressure on the industrial sector’s profitability, but we believe the energy sector could hold up relatively well in the event of an economic downturn. As for artificial intelligence, we believe companies able to monetise proprietary (as opposed to open-source) intellectual property in areas such as advanced conductors and cloud infrastructure stand to be among the major beneficiaries of AI’s rapid development. 

Fixed income Revived hawkish rhetoric from central banks has led to a surge in shorter-term bond yields in recent weeks but longer-term yields have been better behaved as medium-term inflation expectations become better anchored. Persistent inflation problems mean that the rise in UK bond yields has been particularly sharp, which has already led us to revise up our year-end forecast for gilts. By contrast, Swiss government bonds have been star performers this year due to comparatively low inflation. But we have decided moved to an underweight position on Swiss bonds, believing further gains will be harder to come by. Noninvestment-grade corporate bonds have benefited from risk-on sentiment in recent weeks, leading to a tightening of spreads over government bonds. However, as credit conditions tighten we see cracks opening up in the lowest-rated bonds, with default rates already climbing. We continue to favour short-term investment-grade (IG) bonds, which are offering attractive risk-adjusted returns. We have decided to switch to an overweight position on US IG and a neutral one on euro IG given that the former offer superior nominal and real yields. But we remain underweight noninvestment-grade equivalents. 

Commodities, currencies A strong rebound in oil consumption in emerging markets contributes to our belief that demand could outstrip supply in H2, despite a possible economic downturn in the US. We therefore believe recent oil prices represent a trough. We are less optimistic on copper prices in the short term given signs of slight oversupply. In currencies, one of the most noteworthy developments of recent weeks has been the yen’s decline as the Bank of Japan (BoJ) sticks to its accommodative policy stance. However, there have been inklings of official intervention to prop up the currency and the BoJ could move to make ‘technical adjustments’ to its yield-curve control, thus helping stabilise the yen. We have decided to move from a tactical overweight position on emerging-market currencies versus the US dollar to a neutral one, in part because the rate gap with developed markets has been narrowing. 

Asian assets We have a neutral stance on Asian equities overall. Equities in China have lagged of late, but valuations now are cheap, especially in view of expectations for double-digit earnings growth this year. However, our approach for now remains focused on western companies with appropriate exposure to a possible revival in Chinese growth momentum. Valuations are also reasonable in the rest of Asia. Asian corporate bonds have been outperforming emerging-market (EM) bonds in general year to date, with India a stand-out performer. Nonetheless, we see continued ups and downs in the Chinese high-yield market as the property sector tries to find its feet. Within a neutral stance on hard-currency EM corporate bonds overall, we continue to favour high-quality, investment-grade bonds in Asia. In currencies, the renminbi, like the yen, has come under pressure of late as monetary policy is eased in China to try to restore growth momentum. However, we believe further broad economic stimulus and official intervention could limit further renminbi weakness if the Chinese recovery stabilises and the US slows.

Asset-class views and positioning

We remain underweight US equities given the narrowness of recent index gains, tightening credit conditions and loss of momentum in parts of the US economy. We note that the ‘risk premium’ demanded of equities has disappeared and that short-dated fixed-income instruments match the earnings yield on US equities. We believe that the AI-inspired rally has already gone far and believe a stock-by-stock, active-management approach is more warranted than ever. We have also been using continued low equity volatility to build up portfolio protection at a reasonable price. Even adjusted for sector differences, valuations on European and Japanese stock indexes look more reasonable than in the US. We continue to like US Treasuries, which are offering attractive yields and should serve to protect balanced portfolios if the US enters recession. 

Three investment themes 

i. The return of the bond vigilantes. The market is pressing policymakers to bring inflation expectations under control by demanding higher bond yields. Our expectation that high policy rates could persist means that the current attractive rates on short-term investment-grade bonds could remain in place for some time and look particularly attractive as inflation is brought under control. 

ii. A time for active management. The upcoming earnings season is set to show wide dispersion in the performance of individual sectors and companies. We believe financial and operational pressure on companies makes a strong case for preferring an approach to equities based on bottom-up stock selection over a passive investment strategy. We believe a similar active approach is warranted when it comes to corporate bonds, where we continue to concentrate on quality.

iii. Volatility as an asset class. We believe recent drops in equity volatility point to signs of complacency. Treating—and trading—volatility as an asset class in its own right therefore remains an important investment theme for us. As economic uncertainty grows and liquidity is drained from the market, H2 could be a good time to invest in volatility. We see various option strategies, including equity hedges and capital-protected notes, as ways to protect portfolios in the event or a renewed pick-up in volatility.