CIO Lens Q4 2023: steering through market cross-currents

In this quarter’s CIO Lens, available in full here:

• Johanna Kyrklund, Co-Head of Investment and Group CIO, reflects on a trendless summer for markets, with different influences causing increased divergence, and explains why the multi-asset team has moved tactically positive on US equities.
• Nils Rode, CIO Private Assets, provides some guiding principles the team considers important to investing in private markets through the new economic cycle.
• Andrew Howard, Global Head of Sustainable Investment, looks at how sustainability as a theme runs through the 3Ds of decarbonisation, deglobalisation and demographics.
• Our multi-asset team takes you through their asset allocation views across all the major asset classes, including why they’ve upgraded their overall view on equities and moved to neutral on bonds.
• Chief Economist Keith Wade and his team discuss their current economic risk scenarios, including two new additions: "hard landing" and "higher commodity prices".

Johanna Kyrklund:

In Rome, where I grew up, people often talk about the type of wind that is blowing. There are names for all eight winds, whether it’s the chilly northerly Tramontana or the hot southerly Scirocco. And the temperature and mood in the city change significantly along with the wind.

I’m reminded of this when I think about the trendless markets we’ve been seeing over the summer, which have blown hot and cold, affected by different forces and events.

Indeed, Federal Reserve (Fed) chair Jerome Powell likened making policy decisions currently to "navigating by the stars under cloudy skies”.

Diverging dynamics

While inflation has been moving in the right direction, resilient growth has raised concerns that this rate hiking cycle isn’t over yet.

And there's also been significant regional divergence. This is a trend I expected to see as interest rate cycles re-emerge, but it’s been interesting to see the cross currents being felt after such a long period of regions moving in unison.

The US economy is still a little too hot for comfort, while China is struggling with a weak property sector. Japan has been soaring because of the stance of the central bank, while Europe has had a decidedly soggy summer from a growth perspective.

Impact of the 3Ds

As we’ve outlined in our medium-term roadmap over the last two years, we expect inflation to be higher for a given level of growth due to a number of structural trends such as labour scarcity, a shortening of supply chains, and the energy transition. We’ve broadly categorised these as the “3Ds” of demographics, deglobalisation and decarbonisation.

We then overlay this roadmap with a more cyclical view, based on the stage of the interest rate cycle. In this regard, we believe we are reaching a plateau – more Table Mountain than Matterhorn, as some have described it. This is as central banks observe the impact of their rate hikes so far and see signs that inflation is moving in the right direction.

Multi-asset positioning

As we discussed in last quarter’s CIO Lens, on the multi-asset team we accepted in June that the US economy was proving to be more resilient than we had expected. As a result, we closed our underweight position in equities and have moved to a tactically positive view on US equities as we go into year end. 

As we expect bond volatility to stabilise, and given that the US economy is still generating positive growth, we believe that the soft landing narrative can allow the S&P 500 to deliver further gains. We remain positive on Japanese equities, given the Bank of Japan’s stimulative stance, and we are negative on German equities where the economic slowdown is gaining some momentum. In summary, we are exploiting regional divergence in our equity views.

Equity styles are harder to discern; on the one hand, a higher interest rate environment should support value stocks, as near-term earnings tend to become more valuable at such times. But on the other, technological disruption continues to be a powerful force and supports growth stocks.

Looking at fixed income, we expect yields to stabilise as inflation subsides but given that we are not expecting a imminent recession or a Fed pivot, we prefer to own European investment grade debt as a way of increasing our sensitivity to interest rates with an attractive yield. 

We have previously talked about the long-term benefit of commodity-related exposures in a world of more constrained supply and heightened geopolitical risk. We also view them as a good source of diversification if growth and inflation remain higher than expected.

In summary, we are focused on regional opportunities within equities, European investment grade debt and commodities. But we’ll be keeping a close eye on which way the wind is blowing.

Read the full CIO Lens here.