Monthly house view | September 2023

Macroeconomy

China’s difficulties have been weighing on sentiment elsewhere, with flash purchasing manager indexes for global manufacturing declining again in August. There has also been erosion in services indexes. And exports from leading trading nations declined for the third consecutive month in June. However, we not expect global growth to collapse, in part because of the continued performance of the US economy. Indeed, despite stringent monetary policy and a rise in real interest rates, we have raised our real GDP growth forecast for the US this year from 1.6% to 2.1%.  Although inflation is gradually declining, we do not expect any rate cuts this year in the US. Our growth forecast for the euro area is feebler (0.5% real GDP growth for this year), with a good chance of another rate hike from the ECB in September.  Downside risk in the euro area have increased, in part because of China’s problems. However, expect growth momentum in China to recover modestly through to the end of the year due to gathering policy stimulus. While subject to downside risk, we have therefore left our 2023 GDP growth forecast for China unchanged at 5.2%. By contrast, our 1.3% forecast for Japan is subject to upside risk due to a strong GDP figure for Q2.

Asset classes

Equities

Q2 results were generally better than lowly pre-reporting season expectations, with margins in the US proving far more resilient than feared. Yet equity indexes lost ground through much of August as investor remained concerned about valuations, especially in the US. For this reason, we remain underweight US equities while we are neutral on European and Japanese equities. Sector wise, there were signs that European consumer staples companies could be on the cusp of improving their profitability metrics in the wake of their US peers. After standout Q2 results, we continue to prefer European banks to their US equivalents on valuation grounds. In tech, pricing action in August betrayed growing nervousness about valuations, even though Big Tech generally showed healthy organic earnings growth in Q2. Emerging-market indexes underperformed developed-markets ones in August, reflecting poor news out of China. With foreigner investors sceptical about seeing a credible policy backstop, there have been net outflows from Chinese equities. 

Fixed income

While Asian central banks have been timid about rate cuts, growth concerns and slowing economies have spurred central banks in Latin America to start cutting rates. Overall, which still higher than their long-term average, local-currency EM yields could be expected to fall. A sputtering US economy could drag yields down again in the US, and with them the USD. This could further support local-currency EM bonds. Corporate bonds in developed markets have remained low and in a narrow range over the past month as talk of a ‘soft landing’ has gained currency. The resilience of US credit in particular can be put down to a number of other factors, including a historically low proportion of corporates’ pre-tax profits eaten up by interest payments. While we still expect yields to widen, we have lowered our year-end forecast for high-yield spreads on both US and euro noninvestment-grade debt. 

Currencies, commodities

China’s problems and fading prospects for prolonged policy aggressiveness in the euro mean that August was another good month for the US dollar. But our view remains that the US dollar is vulnerable to a downturn in the domestic economy. Assuming a decline in real US rates from their present high levels, we think the Japanese yen and gold could attract interest again in the coming months. We have decided to reduce our position on the Swiss franc from neutral to underweight in light of the gains that currency has made so far this year and fading currency intervention by the Swiss National Bank. On the commodities front, we have reduced our year-end forecast for Brent crude from USD110 to USD95. This takes account of a continued supply deficit on the one hand and weakening oil demand from China on the other.

Asset-class views and positioning

There are two changes to our asset positioning this month. We have moved from a neutral to overweight position in emerging-market government bonds in local currency (reflecting attractive real yields) and from a neutral to an underweight one on the Swiss franc. We maintain an overweight position on US Treasuries but remain relatively cautious on assuming duration risk, in keeping with our strategy to focus on liquidity and defending portfolios. Tight spreads on noninvestment-grade corporate bonds continue to make us nervous, whereas current yield on short-dated investment-grade credits remain attractive.

In equities, despite a better-than-expected Q2 earnings season, our concerns about US valuations remain intact, so that we continue to have an underweight position in US equities and maintain our focus on quality. By contrast, we are neutral on stocks in Europe and Japan where valuations are less challenging. A good economic performance, governance reforms and an accommodative central banks make up hopeful about Japanese stocks. We are also neutral on Asian stocks outside Japan, in large part because we are hopeful that economic and property-sector difficulties can be stabilised in China, which will lead to the emergence of new opportunities.

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 given signs of continued complacency about the way ahead. We continue to see the value of various option strategies to protect portfolios and to monetise uncertain markets.
• The return of the bond vigilantes. Pressing policymakers to keep inflation expectations under control by demanding high bond yields, the ‘bond vigilantes’ are back. Our expectation that high policy rates could persist means that the current rates on investment-grade bonds of up to five years maturity look attractive (US bonds in three-to-five year range were recently carrying a yield of around 5.7%) and could remain so as long as inflation is brought under control and any economic downturn is mild.
• From deglobalisation to friend-shoring. A long period of offshoring by western firms when globalisation was at its height has given way one where ‘re-shoring’ and ‘friend-shoring’ have taken hold. We believe a number of countries could benefit from this process. These include India, ASEAN members, Mexico and some central European countries.  We believe that the reconfiguring of global supply chains could also boost some industrial-sector companies due to the increased capital expenditure involved.