A stronger case for equities

We slightly increased our global equity exposure over the summer and at the start of October, the first increases in over eighteen months. The change in direction of travel is more significant than the resulting change in asset allocation. We remain underweight equities compared to our long-term strategic target, though by a little less than before.

Since I last wrote, the US economy has remained resilient and inflation has continued to fall. Against this backdrop, corporate earnings have been relatively robust and there are tentative signs that margins may be stabilising. These factors suggest higher equity exposure could be warranted.

We are proceeding cautiously, however. One big question mark is how the Federal Reserve will approach its battle against inflation. Getting it all the way back down to 2% (from 3-4% currently) could come with a higher economic cost than the larger decline we have seen so far. The Fed may be forced into unexpected rate rises – or turn out to be slightly more tolerant of inflation than it cares to admit

The ongoing strength in the US dollar should help the Fed as it makes imports slightly cheaper. However, the rise of the US currency is a reminder of challenges elsewhere, especially in Europe and China. The US has generally been able to shrug off economic weakness overseas, but it becomes more problematic if it jeopardises financial stability or fuels geopolitical tensions. In this context, we note the reported ban on Chinese officials using iPhones for work. In itself, the move is not significant for Apple, but it would be far more worrying if it marked the start of a broader trend.

The US reigns supreme once again

Global equities performance leadership (in USD)

^{Source: Refinitiv Datastream, MSCI and Schroders Strategic Research Unit. Data to 31 August 2023 in US dollars}

Past performance is not a guide to future performance and may not be repeated.

Normal service resumed in bond markets?

While global equities have delivered impressive returns this year, government bonds have been struggling. We remain comfortable with our slight overweight position in fixed income, however, as we continue to only hold shorter dated bonds.

Bonds now offer attractive levels of income. And, while interest rates are set to remain “higher for longer,” at some point capital values could rise as investors focus on interest rate cuts (bond prices rise as interest rates fall).

It is also worth noting that the usual relationship between bonds and equities has been restored this year, after it broke down in 2022. Growth has been stronger than expected, equities have been rising and bonds falling. This pattern came under pressure in September after the Fed said that it would need to keep rates high. However, if inflation continues to fall, we anticipate that bonds should once again offer some portfolio protection if equities stumble.

Don’t overlook alternatives

Though alternative investments face stiffer competition from cash and fixed income, we continue to see their appeal. One reason for this is their ability to protect against inflation surprises. We have exposure to a basket of commodities, which has performed strongly as oil prices and other commodities rise.

We also see opportunities in the listed alternatives space. Our thesis that many UK investment companies are undervalued was borne out by a recent takeover in the music rights industry. Round Hill Music, which we hold in our Diversified Alternatives Asset Fund, was acquired by a US rival at a 67% premium to its price before the transaction was announced.