SNAPSHOT2 min read

Views at a glance - May 2023

Equity markets have remained resilient, despite ongoing stress in the US banking sector.

09/05/2023
Elephant and Mule cartoon - Republican and Democrat

Authors

Caspar Rock
Chief Investment Officer

Stock markets hold onto gains

Stress in the US banking sector claimed another victim early this month: California’s First Republic Bank was taken over by US authorities before an emergency sale to JPMorgan. The news resulted in further losses for US bank shares but has not caused significant declines in broader equity markets. Both US and global shares remain around 8% higher year-to-date in USD terms (4% in GBP terms). Investors may be taking comfort from the fact that threats to financial stability means the peak in US interest rates is closer – a view supported by the latest statement from the Federal Reserve. However, investors may be too optimistic about the prospect for interest rate cuts given the persistence of inflationary pressures. They may also be underestimating the economic risks from tighter banking regulation and lower levels of lending. Both factors reinforce our view that the US will face a mild recession over the coming year.

Is inflation becoming embedded?

Core inflation in the US, UK and Eurozone remains at or above 5.5% and is not yet on a clear downwards trajectory. Signs that labour markets are cooling, especially in the US, suggest this should be on the horizon. However, central banks will be wary of prematurely easing monetary policy and allowing inflation to rise from an elevated base, as was the case in the 1970s. The UK perhaps faces the greatest challenge. It is the only major economy where headline inflation remains in double digits. The latest inflation figures also significantly exceeded the Bank of England’s forecasts, undermining its inflation-fighting credibility. The BoE appears to be further away from an end to interest rate rises than the Fed or ECB.

Debt ceiling deadline moves closer

Concerns over the US debt ceiling are another source of potential volatility. The risk was highlighted by Treasury Secretary Janet Yellen, who warned Congress that the US could be forced into default as early as June 1 without a deal to increase borrowing limits. In 2011, brinkmanship over an agreement resulted in significant turbulence in markets – and the downgrade of the US credit rating. Investors may be anticipating a repeat of this drama, with the cost of buying insurance against a default on US government debt now at record levels. We expect that an agreement will be reached – but this will come at an economic cost: a deal is likely to include some combination of tax increases and spending cuts, further weighing on the outlook for growth and corporate profits.

Portfolio positioning

Our underweight exposure to equities remains appropriate, though we are looking for opportunities to add as and when markets begin to better reflect the more challenging economic environment. As things stand, other asset classes look relatively more attractive. We have been gradually increasing our exposure to government bond markets, which should start to offer more defensive characteristics as inflation falls from very high levels. We have recently been switching some of our fixed income exposure from US Treasuries into UK gilts, based on the view that markets may be overly-optimistic on US rate cuts. Gold has also been performing well and we maintain some exposure as part of a blend of defensive assets. 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

  • The base case remains for slowing global growth with recent disruption in US regional banking sector increasing the probability that the US will fall into a recession.
  • China remains a bright spot, with the potential for further consumer-driven growth as the economy reopens.
  • While inflation has proved resilient, we continue to expect headline measures to moderate gradually, although remain above central bank targets.
  • Central banks may continue to raise interest rates in the near term and then pause.

Valuations

  • Global equities have re-rated this year driven by improving investor sentiment, although still look relatively better value compared to recent history, particularly outside of the US.
  • Government bond valuations look more attractive given the sizeable yield moves we have seen since the start of 2022.
  • Valuations of both equities and credit remain vulnerable to a meaningful deterioration in corporate earnings.

Sentiment

  • Investor sentiment has improved this year and in the near-term volatility remains subdued.
  • Sentiment could be tested by weaker economic data, ongoing unrest in the US banking sector and the potential for further rate rises.
  • Consumer confidence has improved but remains weak compared to historic levels and could be tested further as the economic impacts of rising interest rates become more apparent.

Risks

  • Further disruption to US regional banks, tighter lending standards and the potential for a “credit crunch.”
  • Persistently elevated levels of inflation, which would warrant continued hawkish central bank policy.
  • A further escalation of the Russia Ukraine conflict and the European energy crisis remains a possibility.
  • The European economic outlook has improved and global growth could be supported by China.


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. The economic outlook remains uncertain. Ongoing banking sector disruption and the potential for tighter lending standards have increased the probability of a US recession. Corporate earnings have surprised positively in the recent reporting season. Valuations have increased, driven by stronger investor sentiment and arguably do not reflect the risks to economic growth.

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. We favour absolute return strategies with the ability to deliver less correlated returns as well as 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. The economic outlook remains uncertain. Ongoing banking sector disruption and the potential for tighter lending standards have increased the probability of a US recession. Corporate earnings have surprised positively in the recent reporting season. Valuations have increased, driven by stronger investor sentiment and arguably do not reflect the risks to economic growth.

UK

🔵

🟠

The UK economic outlook remains challenging. While inflation should moderate, we expect it to remain elevated in comparison to recent history. The UK consumer could remain under pressure and sentiment may continue to be weak. Whilst domestic companies face an uncertain backdrop, valuations are cheap and opportunities remain.

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.

North America

🟠



Recent disruption to US regional banks have increased the chances of a recession as greater regulation and tighter lending standards have the potential to weigh on economic activity. These risks to growth may have implications for monetary policy, although a resilient labour market and continued inflationary pressure means rates could rise further in the near term. Valuations remain elevated relative to other global equity markets whilst recent corporate earnings reports have been mixed.

Japan

The reopening of Japan’s international borders and the improved outlook for China could benefit the Japanese economy, though large-cap exporters would face headwinds from a global recession. The Bank of Japan is under pressure to tighten monetary policy but its stance is likely to remain relatively supportive for risk assets in the near term. Valuations remain supportive.

Asia/ Emerging markets


🔵



🔵


The relaxation of China’s “Zero Covid” policy and reopening of the economy, as well as continued support from the PBoC, represents a significant economic support for China and the region more broadly. Valuations continue to be supportive 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. We prefer UK gilts given more attractive yields and potential support from a dovish monetary policy shift.

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 over 1.5% for the first time since 2010. Market expectations of future inflation have moved higher this year and remain above long-term averages.

Emerging markets

🔼

🔵🔼

The reopening of the Chinese economy and 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. We favour absolute return strategies with the ability to deliver less correlated returns as well as 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


🔵



🔵


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


🔵



🟢


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.

Authors

Caspar Rock
Chief Investment Officer

Topics

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.