Views at a glance – August 2022

Some stability returns to markets

After steep falls earlier in the year, stock and bond markets have both enjoyed a modest rebound over the summer. While reported inflation remains high, prices of many commodities have fallen, suggesting that inflationary pressures could start to ease over the coming months – especially for manufactured goods. Investors may be hoping this will allow the Federal Reserve to slow the pace of rate rises and achieve a “soft landing”. However, this could prove optimistic. The Fed may have to keep raising rates to ensure that inflation also slows in the larger services sector. And there are already signs that the US economy is slowing significantly, with early estimates suggesting that it experienced two consecutive quarters of contraction, the most common definition of a recession.

ECB raises interest rates for the first time in eleven years

The ECB announced a larger-than-expected rate hike last month, taking its deposit rate to 0% and ending a policy of negative interest rates. The ECB arguably has an even more difficult task than other major central banks in its efforts to bring inflation under control. European gas prices remain at record highs, keeping inflation high and depressing growth. Italy’s high debt and unstable politics are also becoming a concern for investors, reviving memories of the eurozone debt crisis. The ECB has introduced a new tool called the Transmission Protection Instrument that is intended to prevent bond spreads from widening and avoid a repeat of the events of a decade ago.

A change in direction for the UK

Italy is not the only European country grappling with political uncertainty, as the UK Conservative party picks a new leader – and a new Prime Minister. Sterling has been weak, but for now this appears to be more a reflection of the country’s high inflation and low growth than the political situation. Even so, the outcome of the leadership contest could result in a meaningful shift in economic policy. Rishi Sunak has spoken against unfunded tax cuts, while his rival Liz Truss has pledged both tax cuts and higher spending. She has also said she would “look again” at the Bank of England’s mandate, suggesting it had not been “tough enough” on inflation. The Monetary Policy Committee has since followed the ECB and raised interest rates by 50 basis points.

Portfolio positioning

The risk of a global recession remains elevated and we therefore continue to focus on the defensiveness of our portfolios. We have been reducing our overall equity exposure and have cut our allocation to smaller and more cyclical companies. Over the course of the year, we have benefited from our underweight position in fixed income and overweight allocation to alternatives. However, government bond yields have risen and now look relatively more attractive, providing the opportunity to gradually add back to these positions. This would further increase the defensiveness of portfolios. We also believe that real assets like property, renewable energy and infrastructure can benefit multi-asset portfolios in periods of high inflation. Safe havens such as gold and the US dollar should also provide some protection in more challenging environments.

Outlook

	Economics	An uncertain outlook with slowing economic growth and rising risk of recession. Moderating commodity prices and fewer supply chain disruptions could ease US inflationary concerns. Headline inflation in the UK and Europe could move higher given greater reliance on commodities from Russia and Ukraine. Weaker consumer spending could have broader economic implications. Interest rates are likely to continue to rise in the near term.
	Valuations	Global equities have meaningfully de-rated this year and now look more attractively valued. Government bond valuations look relatively more attractive given the sizeable moves we have seen this year, although remain vulnerable to further interest rate rise. Alternative assets including absolute return funds and commodities look attractive as diversifiers.
	Sentiment	The potential for a policy pivot to combat slowing economic growth has boosted investor sentiment in the short term. The risk of recession and the inflationary impacts of ongoing geopolitical tensions are likely to continue to test investor sentiment. Consumer confidence remains close to all-time lows and business optimism surveys are weak.
	Risks	A consumer-led recession. Persistently high inflation and higher-than-expected interest rates. Threats to global economic growth from rolling lockdowns in China. Further escalation of the Russia Ukraine conflict.

Asset Classes

Asset classes	Current positioning	Medium term view	Current views
Equities			Near-term sentiment has been boosted by the potential for a shift in policy to combat slowing economic growth. This has benefited interest rate sensitive “growth” sectors which suffered heavy losses during the first half of the year. However, the risk of recession, continued high inflation and deteriorating corporate earnings could all keep volatility elevated. We continue to prefer higher-quality, large cap companies which can better navigate a more challenging environment. We maintain conviction in long-term secular themes including technology and energy transition.
Bonds			Nominal government bonds have defensive characteristics in a more challenging macro-economic environment. We prefer US Treasuries, due to their relatively higher yields. We are starting to see opportunities in short-dated gilts, which offer a higher yield than cash. Within credit. we like short-dated, high-quality asset backed securities which offer a relatively attractive yield. They also benefit from floating interest rates, which are more appealing in a rising interest rate environment.
Alternatives			Continue to offer attractive diversification characteristics in a 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.
Cash			Cash has defensive qualities in potentially volatile markets, while rising interest rates may offer some potential for returns.

Equities

Asset	Current positioning	Medium term view	Current view
Equities			Near-term sentiment has been boosted by the potential for a shift in policy to combat slowing economic growth. This has benefited interest rate sensitive “growth” sectors which suffered heavy losses during the first half of the year. However, the risk of recession, continued high inflation and deteriorating corporate earnings could all keep volatility elevated. We continue to prefer higher-quality, large cap companies which can better navigate a more challenging environment. We maintain conviction in long-term secular themes including technology and energy transition.
UK			Valuations remain relatively attractive. While large cap performance has benefited from greater exposure to cyclical sectors, global growth concerns could weigh over the medium term. The Bank of England remains under pressure to continue normalising policy given elevated inflation, despite domestic growth concerns.
Europe			Given Europe’s greater economic exposure to Russia (particularly through energy) the inflation and growth outlook for the region looks more challenging and could pressure consumer and investor sentiment. The ECB is under pressure to normalise monetary policy.
North America			The US economy has the potential to be greater self-sufficiency in both energy and agriculture and is therefore more insulated from geopolitical unrest. Consumer sentiment remains close to all-time lows and business optimism is weak. However, valuations have moderated and earnings remain relatively robust.
Japan			Lower risk of inflation, more fiscal support combined with accommodative monetary policy could lead to improved domestic economic growth driven by consumption. Economic exposure to China could be beneficial if Covid restrictions continue to ease.
Asia/ Emerging markets			In the near term, fewer Covid restrictions have benefited economic activity. Chinese lending activity look to be improving with political support for higher spending to boost growth into 2023. Valuations are now at a significant discount to 15-year averages. China’s “Zero Covid” policy and potential for rolling lockdowns remain a risk and there is continued uncertainty around the property sector.

Bonds

Asset	Current positioning	Medium term view	Current views
Bonds			Nominal government bonds have defensive characteristics in a more challenging macro-economic environment. We prefer US Treasuries, due to their relatively higher yields. We are starting to see opportunities in short-dated gilts, which offer a higher yield than cash. Within credit. we like short-dated, high-quality asset backed securities which offer a relatively attractive yield. They also benefit from floating interest rates, which are more appealing in a rising interest rate environment.
Government bonds			Nominal government bonds have defensive characteristics in a more challenging macro-economic environment. Valuations look relatively more attractive given the sizeable moves we have seen this year, although remain vulnerable to further interest rate rises. We prefer US Treasuries due to relatively higher yields.
Investment grade			We prefer shorter-duration and higher-quality credit in the near term. given the potential for further spread widening. Opportunities remain within asset backed securities which offer a relatively attractive yield and floating interest rates.
High-yield			Recent spread widening offers some valuation support while higher yields and shorter duration characteristics look attractive. Default rates remain low although face headwinds from a rising cost of debt and a more challenging economic backdrop.
Inflation-linked			The potential for more persistent inflationary pressures could keep inflation expectations elevated relative to recent history. We see opportunities in UK inflation-linked gilts given a more challenging inflation outlook for the UK relative to the other areas of the world.
Emerging markets			Certain emerging markets could see near term balance sheet deterioration as a result of a more uncertain global economic backdrop and continued Covid headwinds. There is selective value across both US dollar and local currency debt.

Alternatives and cash

Asset	Current positioning	Medium term view	Current views
Alternatives			Continue to offer attractive diversification characteristics in a 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.
Absolute Return			We see select opportunities in equity long/short strategies given increased stock dispersion and diversification characteristics. However, falling inflation could see the correlation between bonds and equities fall. 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 digital infrastructure, specialist property and and exposure to private companies.
Commodities			Gold is attractive as a diversifier and should provide portfolio insurance in the event of a meaningful equity market correction or economic growth shock. Broader commodities can hedge against further rises in inflation.
Equity-linked income strategies			Offer attractive returns especially in times of heightened volatility, but we acknowledge the shorter-term correlation with equities.
Cash			Cash has defensive qualities in potentially volatile markets, while rising interest rates may offer some potential for returns.

Key

	Positive
	Positive/neutral
	Neutral
	Negative/neutral
	Negative
	Up from last month
	Down from last month

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.