SNAPSHOT2 min read

Views at a glance - June 2023

A debt ceiling crisis has been averted, but challenges remain.

05/06/2023
American politics

Authors

Caspar Rock
Chief Investment Officer

A better mood in markets

Just two months ago, investors were fretting about US bank failures. At the start of June, they are cheering a debt ceiling deal and the emergence of another trillion dollar company, Nvidia. Along with other large tech companies, the value of Nvidia has soared as investors grow increasingly excited about the prospects for AI. There are other reasons for optimism. Inflationary pressures continue to ease, although remain above expectation in the UK, and earnings remain resilient. However, with interest rates still at far higher levels than companies and households have been used to, fragilities remain. There are also signs that global economic activity, especially in manufacturing, is starting to slow. This may explain why the performance of US stocks excluding technology has been far more muted.

Debt ceiling battle deferred

The US House of Representatives has agreed to a deal that suspends America’s $31.4 trillion limit on borrowing until the start of 2025. Approval by the Senate and President is expected to follow. While this removes a key near-term risk for the US economy, there are challenges ahead. It is possible that the Federal Reserve further raises interest rates over the summer. Investors may also start to pay greater attention to next year’s US election. Much may change before Republicans and Democrats must choose their nominees, but for now Trump and Biden are the favourites. Even if we do not see a rerun of the 2020 contest, the election could trigger an escalation of the long-running tensions between the US and China. This could depress the outlook for profits and growth in both countries.

Will China’s recovery disappoint?

It looks increasingly likely that China’s post-Covid recovery is not going to be as strong as that enjoyed by other major economies. While it was always expected that the rebound would be focused on services, markets were still disappointed by recent survey data suggesting that Chinese manufacturing may have contracted in May. Even in the more buoyant services sector, data has been falling somewhat short of expectations. The relatively subdued recovery may reflect the fact that excess household savings built up during Covid were lower in China than many Western economies. The property sector also continues to be a significant headwind to confidence and activity, leading to some speculation that the government may introduce additional support measures.

Portfolio positioning

Given our view that the US will fall into recession late this year, our underweight exposure to equities remains appropriate. However, we are looking for opportunities to add as and when markets begin to better reflect the economic challenges ahead. Within equities, we are modestly increasing our exposure to Japan, given an increased focus on corporate reform.

We are now overweight government bonds, which should start to offer more defensive characteristics as inflation continues to fall. 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. 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.
  • 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. While domestic companies face an uncertain backdrop, valuations are cheap and opportunities remain.

Europe

🟠



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.

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’s stance is likely to remain relatively supportive for risk assets in the near term and valuations remain supportive.

Asia/ Emerging markets


🔵



🔵


The reopening of the Chinese economy and continued support from the PBoC represent significant sources of support for China and the region more broadly. Valuations remain 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.

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 your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.