Our multi-asset investment views - June 2022
Our multi-asset investment views - June 2022
MAIN ASSET CLASSES
We maintain our negative view on equities. Uncertainty around earnings is still not adequately reflected in valuations while discount rates are at best stable given the uncertainties around interest rates. Interest rates are a key component of discount rates, which are used to discount a company’s future expected earnings and cashflows in order to compute its theoretical value in today’s money, or “present value”. Present values are considered when valuing a company’s shares.
We remain neutral as we think the US 10-year government bond is fairly priced based on our model, but real yields (nominal yields minus inflation) look too low. With inflation continuing to accelerate while growth expectations are falling, we require higher yield levels to compensate us for the potential volatility.
We downgrade our score for commodities to neutral as we are starting to see signs of demand falling, particularly in the energy sector, as global growth weakens.
Our indicators increasingly suggest we are at the late stage of the economic cycle. They signal that a slowdown in economic activity may be coming ahead. Median credit spreads are usually higher and their ranges wider at such a “late cycle” stage, however valuations have improved, leading us to give credit a neutral score overall. The economic cycle is the period in which an economy moves from a state of expansion to one of contraction, before expanding again. The credit spread is the margin that a company issuing a bond has to pay an investor in excess of yields on government bonds and is a measure of how risky the market perceives the borrower to be.
The US continues to be the most vulnerable region to further a de-rating in valuations driven by slowing earnings growth.
The defensive and commodity tilts of the FTSE index continues to help the region on a relative basis.
Earnings momentum has turned positive in Europe. However, the recently adopted “hawkish” stance by the European Central Bank (ECB) will be a challenge for equity returns. Monetary policymakers are often described as hawkish when expressing concerns about limiting inflation.
Japan is one of the few regions where inflation is welcomed. This should lead to some relative outperformance against other parts of the developed world.
Global Emerging Markets1
While the headwinds facing China seem to be moderating, other emerging market (EM) countries face mounting inflationary pressure and we retain a neutral score overall.
We upgrade to positive with China finally looking to be turning a corner on lockdowns. This should ease some of the supply bottleneck issues in the country.
EM Asia ex China
We believe that other regions in the EM universe appear more attractive, notably commodity exporters in Latin America. Inflation is becoming a problem for the EM Asia ex China region.
We maintain our neutral view. Although the sharp move higher in yields this year does now offer a better entry point as growth expectations fall, we need to see inflationary pressures abate before turning positive.
We have downgraded our score to negative as recently announced fiscal subsidies for households could push the Bank of England (BoE) to hike interest rates further.
We have downgraded as the ECB has signalled a significant change in policy, confirming our expectation of rising rates in Europe. With inflation risks on the upside, further rate increases are expected.
The market continues to offer negative yields as the Bank of Japan (BoJ) maintains its policy of targeting yield levels. Under this policy the central bank is purchasing Japanese government bonds in order to hold their yields in check.
US inflation linked bonds
We remain negative as although uncertainty from the Russia/Ukraine crisis appears to have peaked, the Federal Reserve’s (Fed) top priority now is to contain inflation.
Emerging markets local currency bonds
Our view is unchanged as the economic environment remains challenging, with “stagflationary” as well as recessionary risks mounting. Stagflation is a combination of slowing growth and accelerating inflation.
Investment grade credit
We have downgraded US IG, with the consumer sector under mounting inflationary pressure and recession risks rising.
We retain our positive score in European IG as the ECB is being less proactive compared to other central banks and valuations are relatively attractive.
Emerging markets USD
Credit spreads do not compensate for ongoing fundamental weakness leaving valuations looking unattractive in comparison to other regions.
High yield bonds (non-investment grade)
Our negative view is unchanged given the high exposure to the consumer sector. A greater number of issuers could struggle to cover interest and maturities as fundamentals deteriorate further. Maturity refers to the time when the bond issuer must repay the original bond value to the holder of the bond.
We keep our neutral score as credit spreads are relatively attractive but there has been no explicit support from the ECB, which is prioritising raising rates and ending asset purchases.
While supply side issues appear to be priced in, we are starting to see signs of demand destruction as high levels of inflation are subduing global growth. Meanwhile, Russian oil production has yet to fall as reduced European demand is being offset by sales to Asia.
Gold tends to perform well after the Fed has started to raise rates and recession fears loom large. However, there is also a risk that recession worries cause a liquidity squeeze potentially creating issues around the short-term availability of money which could be negative for gold. A liquidity squeeze occurs when funds rapidly become in short supply.
We remain constructive as we expect rising internal Chinese demand as lockdowns ease to offset decelerating developed market demand.
We are positive as input cost inflation remains a key driver. Food security concerns are forcing governments of producing countries to control exports, keeping prices elevated.
We keep our positive score. Global growth prospects continue to weaken, and the recent rise in US consumer prices index (CPI) pushed the Fed to a more hawkish stance. These are supporting the US dollar with its “safe haven” currency status.
The BoE’s Monetary Policy Committee delivered a rate hike with surprisingly hawkish comments but the hiking cycle may be curtailed if downside risks to growth materialise.
The ECB is facing a dilemma of having hawkish forward guidance on rates but lacking concrete measures on managing credit spread levels, which the market may well test to determine where the ECB will step in.
We remain negative as we expect the depreciation in the renminbi (offshore) to continue. This will help to cushion the impact of reduced demand for Chinese exports resulting from high energy prices that are weakening US consumer confidence and retail sales.
We downgrade the Japanese yen as the global rise in bond yields in other markets continues to weigh on the currency.
Swiss franc ₣
In terms of safe haven currencies, we prefer the US dollar over the Swiss franc as we have more conviction in the Fed’s path to normalisation. Normalisation of rates is the process of increasing them from the emergency settings introduced in response to Covid-19, when they were cut close to zero to support economic activity.
1 Global Emerging Markets includes Central and Eastern Europe, Latin America and Asia.
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