Views at a glance – August 2023
Investors are growing increasingly optimistic about a soft landing.
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Better news on inflation
Markets have rallied further over the summer as inflation continues to fall. This has raised hopes of a “soft landing”, with inflation cooling and the economy avoiding a significant economic contraction. However, markets may now be too optimistic. Core inflation remains well above target and central banks will be wary of allowing it to start rising again. So even if interest rates do not rise much further, they are likely to remain at today’s high levels for a sustained period of time. There are already signs that this is taking a toll on economic activity. Recent survey data from the UK, US and Eurozone suggests that manufacturing is in or close to a contraction, with services sectors also slowing. An additional concern is the potential for another rise in food prices, following Russia’s decision to halt Ukrainian grain exports and India’s restriction on rice exports.
UK by-elections suggest a change of power remains likely
Over the remainder of 2023, markets are likely to increasingly focus on upcoming elections in the UK and US. In three recent by-elections, the UK’s Conservative party avoided a worst-case outcome, but the results did little to change expectations that the party will lose power at the next vote. As things stand, this is expected to be held next autumn, but the government could delay until January 2025 or opt for an earlier date in 2024. Either way, the experience of Liz Truss’ short-lived administration may mean the UK’s two main parties avoid significant shifts in economic policy. The US election, on the other hand, could be more consequential for global markets. Russia’s invasion of Ukraine means that the geopolitical backdrop has changed considerably since the last US election. It is possible that the prospect of a second term for Donald Trump adds to international tensions.
How will China support its economy?
Chinese GDP is estimated to have expanded by an underwhelming 0.8% in the second quarter, following a stronger start to the year. It appears that the cyclical boost from the reopening of China’s economy is fading more quickly than expected. Meanwhile, longer-term structural challenges, centered on the property market, continue to weigh on demand and confidence. The government has promised steps to support domestic demand but has not yet made any specific commitments about the size or timing of any significant stimulus measures. As the rest of the world grapples with excessive inflation, China may in fact be moving towards deflation. This could prompt consumers and businesses to delay spending and investment, making it even harder to restart economic growth.
Portfolio positioning
Given our view that the US economy will slow later this year, we retain an underweight exposure to equities. However, we are monitoring for opportunities to add. We have been increasing our allocation to bonds over the past twelve months. Our gilt exposure, which we increased earlier in the year, has benefited from the latest UK inflation data. High levels of inflation in the UK have made meeting inflation plus return targets more challenging in the shorter term. Despite this, we remain confident in the ability to meet inflation-plus targets over the longer term.
Outlook
Economics |
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Valuations |
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Sentiment |
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Risks |
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Key
🟢 Positive
🔵 Positive/neutral
⚪ Neutral
🟠 Negative/neutral
🔴 Negative
🔼 Up from last month
🔽 Down from last month
Asset Classes
Asset classes | Current positioning | Medium term view | Current views |
Equities | 🟠 | 🔵 | We remain underweight equity in the near term, although we continue to look for opportunities to increase exposure. Corporate earnings have positively surprised to the upside in the recent reporting season. Valuations have re-rated driven by better sentiment and arguably do not reflect the risks to economic growth. Market leadership has been very narrow this year, particularly in the US which has been led by large cap technology companies. A broadening of market leadership would suggest the recovery could prove more sustainable. |
Bonds | 🔵 | 🔵 | Nominal government bonds have defensive characteristics in an uncertain economic environment and look more attractively valued relative to recent history. We have continued to gradually lengthen interest rate duration as we move closer to the end of the rate cycle. Within credit we continue to prefer higher-quality securities with attractive yields and emerging market debt, where growth prospects are brighter. |
Alternatives | 🔵 | ⚪ | Continue to offer attractive diversification characteristics in a potentially volatile environment. Within absolute return, we favour strategies with the ability to deliver less correlated returns. We remain positive on real assets with long-dated visible revenue streams and commodities where supply and demand dynamics could support prices. |
Cash | ⚪ | 🟠 | Rising interest rates offer more attractive returns relative to recent history, whilst cash offers optionality in potentially volatile markets. |
Equities
Asset | Current positioning | Medium term view | Current views |
Equities | 🟠 | 🔵 | We remain underweight equity in the near term, although we continue to look for opportunities to increase exposure. Corporate earnings have positively surprised to the upside in the recent reporting season. Valuations have re-rated driven by better sentiment and arguably do not reflect the risks to economic growth. Market leadership has been very narrow this year, particularly in the US which has been led by large cap technology companies. A broadening of market leadership would suggest the recovery could prove more sustainable. |
UK | 🔵 | 🟠 | The UK economic outlook remains challenging as the Bank of England attempts to bring inflation under control. Interest rates are set to continue rising, which could lead to a recession later this year. While domestic companies face an uncertain backdrop, valuations are cheap and there will be opportunities. |
Europe | 🟠 | ⚪ | A warm winter has helped to reduce the near term economic impacts of the Russia Ukraine war and its disruption to energy supply. Sentiment has adjusted to reflect improved near term prospects, although challenges remain with the potential to cause further uncertainty. Valuations remain supportive despite the recent re-rating and corporate earnings continue to be relatively resilient in the near term. |
North America | 🟠 | ⚪ | US equities have performed well recently as a result of growing confidence in the likelihood of a soft landing and the opportunities in AI. Market leadership has been narrow, focussed on a small number of large cap technology companies although there are signs that leadership could broaden out which would suggest a more sustainable recovery. Recent re-rating has left valuations looking less supportive, although in the near term corporate earnings are holding up. |
Japan | ⚪ | ⚪ | Japan’s increased focus on corporate reform has led to a re-rating of its equity market which could have further to run over the medium term. In the near term, Japan’s large cap exporters may face headwinds from slowing global growth. Despite the recent rally, valuations remain relatively supportive. |
Asia/ Emerging markets |
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| China’s post-Covid economic recovery has been underwhelming, though promised government support should provide a boost to confidence. Valuations remain relatively attractive although investors remain cautious and we have not yet seen significant domestic flows into financial markets. |
Bonds
Asset | Curren positioning | Medium term view | Current views |
Bonds | 🔵 | 🔵 | Nominal government bonds have defensive characteristics in an uncertain economic environment and look more attractively valued relative to recent history. We have continued to gradually lengthen interest rate duration as we move closer to the end of the rate cycle. Within credit we continue to prefer higher quality securities with attractive yields and emerging market debt, where growth prospects are brighter. |
Government bonds | 🔵 | ⚪ | Valuations look more attractive given the sizeable yield moves we have seen since the start of last year. We have continued to gradually lengthen interest rate duration as we move closer to the end of the rate cycle to add defensiveness in a potentially volatile economic environment. |
Investment grade | ⚪ | 🔵 | Yields continue to look attractive, although valuations are less supportive at current levels. We prefer shorter-duration and higher-quality credit in the near term given uncertainty around corporate earnings, but could look for opportunities to increase exposure to riskier credit if spreads widen. |
High-yield | ⚪ | 🔵 | Higher yields and shorter duration characteristics look attractive. Default rates remain low although face headwinds from a rising cost of debt, tighter margins, weakening earnings and a more challenging economic backdrop. There remains the potential for spreads to widen if corporate earnings deteriorate which could present opportunities |
Inflation-linked | 🔵 | ⚪ | Valuations are looking more attractive with 10 year US TIPS offering a positive real yield of close to 1.5% for the first time since 2010. Inflation linked bonds continue to offer a hedge against more persistent than expected inflation. |
Emerging markets | ⚪ | 🔵 | The improved growth outlook for the region, as well as potential for further USD weakness, is supportive for the asset class, although risks from a global recession remain. Valuations are attractive relative to other credit markets, particularly in select local currency markets. |
Alternatives and cash
Asset | Current positioning | Medium term view | Current views |
Alternatives | 🔵 | ⚪ | Continue to offer attractive diversification characteristics in a potentially volatile environment. Within absolute return we favour strategies with the ability to deliver less correlated returns. We remain positive on real assets with long-dated visible revenue streams and commodities where supply and demand dynamics could support prices. |
Absolute Return | 🟠 | 🟠 | We see select opportunities in equity long/short strategies given increased stock dispersion and diversification characteristics. However, government bonds are now looking more attractively valued and may provide a better source of portfolio diversification over the medium term. |
Liquid private real assets |
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| Long-dated revenue streams and income characteristics remain attractive in select parts of the market. Within this space we see good opportunities in renewables, digital infrastructure, specialist property and and exposure to private companies. Valuations are more attractive following recent market volatility. |
Commodities |
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| Broader commodities can hedge against further disruption to energy markets, although areas of the asset class are sensitive to slowing economic growth. Longer term, increasing demand from energy transition could support industrial metal prices against a backdrop of tight supply. |
Equity-linked income strategies | ⚪ | ⚪ | Offer attractive returns especially in times of heightened volatility, but we acknowledge the shorter-term correlation with equities. |
Gold | 🔵 | ⚪ | Gold should provide portfolio insurance in the event of a meaningful equity market correction or economic growth shock and will benefit from further USD weakness, although could continue to face headwinds from rising real yields. |
Terms
Spread: the difference in yield between a non-government and government fixed income security.
Duration: approximate percentage change in the price of a bond for a 1% change in yield.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.
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