Monthly house view | November 2023

Macroeconomy

Business surveys offer tentative signs that world growth may be reaching a trough. Barring further escalation in geopolitical tensions, we could begin to see a modest uptick in global growth trends.US GDP growth accelerated again in Q3. But we expect a significant downturn in the current quarter. We continue to expect the Fed’s July rate hike was the last one in this tightening cycle while our annual GDP growth forecast for the US this year still stands at 2.4%. Preliminary estimates showed the euro area economy shrank slightly in Q3 and momentum is set to remain weak in Q4. Our full-year forecast of 0.5% GDP growth faces some downside risk. The latest inflation data chime with our expectation that the ECB’s monetary policy will remain on hold for the foreseeable future.

Chinese GDP accelerated in Q3 but manufacturing activity unexpectedly contracted in October, painting a mixed economic picture. All in all, growth may have troughed thanks to increased policy support, but China’s recovery will likely remain bumpy. Our full-year GDP growth forecast of 5.2% for 2023 remains unchanged for now.

Asset class positioning

Equities: Equity investors are confronted with a ‘wall of worries’ as companies face increased borrowing costs, economies slow, policy rates remain persistently high and geopolitical tensions fester. For now, we believe the more defensive sectors and companies (those with plenty of cash and solid balance sheets) could be expected to perform relatively better than others.

Q3 earnings so far have not been too bad and margins continue to hold up. Excluding the energy sector, quarterly earnings growth on the S&P 500 looks like rising for the first time in four quarters. In Europe, interest rates have been helping banks. At the same time, the breath of upward sales surprises has plummeted. In short, since many stocks (especially top US tech-related stocks) have been priced for perfection, they have been vulnerable to a pull-back when any chink in the armour appears. Question marks over valuations together with volatile bond yields and an expected downturn in the US economy mean we are underweight US equities.

Fixed Income: Amid persistent volatility in long-term bonds, prospects for US Treasuries could be dictated as much by a structurally higher term premium (the extra yield that investors demand for holding long-term US bonds) in a context of growing US deficit as by persistently high policy rates. While a slowdown in US growth could help push down long-term yields again, 10-year US Treasury yields may be at the upper end of the 4-4.5% range by end-December, higher than the 4% we had pencilled in. We could also see less upward pressure on bond yields in Europe, where economies are weaker.

Credit markets remain challenged as rising yields and spreads undercut existing corporate bonds and the increasing cost of debt depresses new issuance. Yields now well above 6% continue to make relatively short-duration US investment-grade bonds (one-to-five years duration) look attractive. But lower-quality, noninvestment-grade bonds and loans are more vulnerable in the current rate environment, as the rise in yields in default rates this year shows.

Currencies/Commodities: Ongoing geopolitical uncertainties mean ‘safe haven’ currencies have been generally strong of late, including the Swiss franc (but notably not the Japanese yen). The US dollar has been propped up for similar reasons. It has also been helped by the continued robustness of US growth, which has kept the Fed’s monetary stance hawkish. But our view remains that a decline in US growth in the coming months should put downward pressure on US interest rates, leaving limited scope for further US dollar strength as long as geopolitical tensions do not worsen further. The going may also get tougher for the overvalued Swiss franc in the months ahead. We remain overweight the Japanese yen as the Bank of Japan tentatively begins to normalise monetary policy in line with inflation trends and we are overweight gold for medium-term portfolio protection.

As long as it remains localised, the impact of the Israel-Hamas conflict on the oil market could be limited. But even if we avoid escalation, the global oil market could remain undersupplied in the coming months and prices close to their current high levels.

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.