Monthly house view | October 2023

Macroeconomy

The latest data releases suggest that global manufacturing activity might stabilise, although activity remains stronger in emerging economies than in developed ones. Likewise, while international trade has continued to plunge, there are signs of stabilisation in new exports orders globally. As for the US economy, we believe that previous Fed rate increases will increasingly kick in and that consumer spending faces increasing challenges. We therefore expect a meaningful loss of economic momentum this quarter. While we think the euro area will just manage to skirt recession, there are considerable downside risks. While core inflation is coming down, we expect ECB monetary policy to remain on hold for some time. There are signs that the drop in economic momentum in China has bottomed out, but we expect only a modest improvement in consumer sentiment, especially as the property market remains mired in difficulty. Japan’s growth has been slowing, but exports have been holding up comparatively well thanks to the cheap yen. We have therefore raised our GDP growth forecast for Japan this year to 1.8%. The rest of Asia presents a mixed picture, with trading nations like Taiwan and South Korea queasy but more-closed economies like India’s proving resilient.

Asset classes

Equities: With the Q3 earnings season almost upon us, concerns remain around valuations. While they fell back in September, valuations on broad US indexes are still not cheap, especially as stocks are challenged by rising bond yields. Concerns about the economic outlook and the spike in funding costs argue for prudence when it comes to US equities’ prospects. We remain neutral on European and Japanese equities given friendlier valuations. Energy and healthcare remain among our favoured sectors. Valuation multiples remain attractive in the energy sector (all the more so as earnings forecasts rise) and so are current and projected cash distributions to shareholders. Despite the impact of higher bond yields, we remain optimistic about certain areas of the healthcare sector such as medtech (including digital health). While clouds still hang over Chinese (and US) consumer spending, we believe the European luxury sector stands to benefit from an uptick in Chinese tourism.

Fixed income: Last month’s sell-off in US Treasuries was replicated in the euro area, where the government bond market had to contend with hikes in energy prices as well as a further increase in the ECB’s deposit rate. Upwardly revised deficit figures for 2024 (notably in Italy) also hurt European bonds as public finances returned to the spotlight. While we expect bond volatility on the euro periphery to ease gradually, there is a risk that spread widening gathers pace in tandem with the debate over a new set of EU fiscal rules. In the corporate sector, limited supply has generally kept spreads within a narrow range and an upsurge in issuance in September was easily absorbed. But with a big rise in refinancing costs and an approaching ‘maturity wall’, we continue to shy away from noninvestment-grade bonds, preferring instead high-quality, investment-grade bonds of limited duration.

Commodities, currencies: Overall, while we expect demand to continue to exceed supply, oil prices are now touching levels that typically dent consumption. We therefore expect the upswing in oil to lose momentum and for Brent crude oil to fluctuate in the USD90-100 range in the coming months. Our year-end target for Brent remains unchanged at USD95. Market revisions of its projections for Fed policy (the Fed funds rate is expected to remain high and fewer rates are being pencilled in for next year) continue to feed into USD strength. We still believe the currency is vulnerable to a downturn in US growth and inflation, which could soften Fed hawkishness. Nonetheless, other currencies such as the euro and the renminbi also face growth issues and a dimming of investor risk appetite could continue to sustain the greenback.

Asian assets: September had a bitter-sweet tasted for investors in Asian (ex Japan) equities, with Asian indexes turning in a negative performance but outperforming their developed-market peers — a rare occurrence this year. Earnings per share expectations have held up better in Asia then in other emerging-market regions and could set up the region for superior performance well into 2024. Nonetheless, stringent Fed policy is shaping up to be an even more important factor in Asian stocks’ prospects than momentum in the Chinese economy. As for Asian corporate bonds, Indian spreads have remained in a tight range, but Chinese spreads have continued to widen. Given the deterioration in risk sentiment towards China, we have generally been finding Asian government bonds in local currency more appealing than Asian credits. The Chinese authorities have managed to stem the decline in the renminbi in recent weeks, although we believe much will depend on improvement in China’s economy and in risk sentiment. Other Asian currencies like the Korean won are vulnerable to the global economic cycle while the rupee could prove more resilient given India’s more closed economy.

Asset-class views and positioning

As creaks appear in the US economy and virtually risk-free US Treasuries continue to offer attractive yields, we are maintaining our underweight position on US equities. While we are neutral on European equities due to lower valuations and less concentrated performance drivers than for the S&P 500, we recognise that shares in Europe also face a challenging economic picture. Overall, in the current environment we remain focused on cash-rich companies and believe in the virtues of active management. We are also neutral on Chinese and broader emerging Asian indexes as we determine how sustainable China’s recovery is. In fixed income, alongside an overweight position in US Treasuries, we continue to like relatively short-duration investment-grade corporate bonds in the US, but are underweight noninvestment-grade bonds as funding costs (and default rates) rise. Despite the US dollar’s continued strength, we maintain our overweight position on the yen as the Bank of Japan moves closer to normalising policy. While gold has been hurt by the rise in US yields, we remain overweight because of what could be a structural upshift in official demand and because of gold’s role in hedging portfolios.

Three investment themes

Volatility as an asset class. Treating—and trading—volatility as an asset class in its own right remains an important investment theme for us, especially as a range of factors increase market nerves. Indeed, economic and market uncertainty is rife, making this a good time to consider investing in various equity options strategies or selling US Treasury volatility as policy tightening tails off.

The return of the bond vigilantes. The market is pressing policymakers to keep inflation expectations under control by demanding higher long-term bond yields. Beyond central banks keeping policy rates ‘higher for longer’, we believe the premium that investors demand for holding long-term government debt could be moving structurally higher. For this reason, we continue to like medium-term US Treasuries, which offer enticing yields for limited duration risk.

Revenge of the balanced portfolio. The negative performance of stocks and bonds alike last year was a painful illustration of how these two fundamental financial assets have become closely correlated. While we expect positive correlation to continue, we believe that a balanced portfolio (typically split between 60% stocks and 40% bonds) will provide important diversification benefits. Our belief that we will see structurally higher yields mean that low-risk bonds have their place in portfolios as a means to mitigate the effects of equity downturns.