SNAPSHOT2 min read

Views at a glance – April 2023

Recent banking sector stress has clouded the outlook for monetary policy.

03/04/2023
Wall street sign

Authors

Caspar Rock
Chief Investment Officer

Bonds and equities rally in a volatile quarter

Rising interest rates were always likely to cause casualties, but investors were still surprised to see a US and Swiss bank among them. While it may still be too soon to sound the all clear, it increasingly appears that SVB and Credit Suisse ran into difficulties because of idiosyncratic challenges and that systemic risks to the banking sector remain contained. Global equity markets have quickly recovered from the shock of the largest US bank failure since 2008 and gained around 3% in the first quarter (in GBP terms, 6% in USD). The impact on bonds has been more enduring, with fixed income markets now anticipating interest rate cuts later in the year. Early in March, investors were expecting US interest rates to end 2023 at close to 5.5%. By the end of the month, they were expected to end the year around one percentage point lower.

Bank stress makes a US recession more likely

Regional banks play an important role in the US economy, especially in the commercial property market. Recent disruption could well lead to greater risk aversion as well as increased regulation. Both factors could result in a slowdown in credit growth, which has historically depressed economic activity. This increases the probability of a US recession over the next year. Longer-term trends also point towards a slowdown. Over the past eighteen months, US consumers have fueled their spending by borrowing more and saving less. With the savings rate now below long-term average levels and debt levels high, these sources of support may soon be nearing exhaustion. This sluggish outlook is not yet reflected in US corporate earnings expectations, which continue to point to growth this year.

Spring Budget underlines UK's challenges

Recent stress in the banking sector originated in the US and Europe, but the FTSE100 was hit hard given its relatively high exposure to financials. Domestic developments have also done little to inspire confidence in the UK market. In the Spring Budget, Chancellor of the Exchequer Jeremy Hunt was able to make the underwhelming claim that the UK had avoided a technical recession – but the growth outlook remains subdued and inflation is set to remain above 4% for much of the year. Schroders’ economists remain skeptical about the impact of Hunt’s plans to boost growth. At the same time, there has been a great deal of public handwringing over the future of the UK’s capital markets as a number of high-profile companies have opted to list in overseas markets.

Portfolio positioning

Our core strategies have negligible exposure to the equity and debt of the banks that have been most impacted by recent developments. More broadly, challenges in the banking sector suggest our underweight exposure to equities remains appropriate. Other asset classes look relatively more attractive. We have been gradually increasing our exposure to government bonds, which should start to offer more defensive characteristics as inflation falls from very high levels. Gold has also been performing relatively well as investors have turned to safe havens. We maintain our exposure as part of our blend of defensive assets. 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

  • We continue to expect slowing global growth, with the US and UK falling into recession. Recent stress in the US banking sector could result in tighter lending standards, weighing on growth.
  • The faster-than-expected reopening of the Chinese economy has been a positive for the global economy.
  • We expect inflation to continue to moderate gradually, although remain above central bank targets.
  • Interest rates could continue to rise in the near term, with central banks potentially pausing further rate rises later in the year.

Valuations

  • Global equities have de-rated over the past year and now look better valued, particularly outside of the US.
  • Government bond valuations look relatively more attractive given the sizeable yield moves we have seen over the past 12 months.
  • Valuations of both equities and credit remain vulnerable to a meaningful deterioration in corporate earnings.
  • There are attractively-valued opportunities across asset classes.

Sentiment

  • Sentiment has been mixed as investors respond to both stress in the banking sector and better-than-expected economic data.
  • Sentiment could be tested by disappointing earnings data and /or continued interest rate rises.
  • Consumer confidence has improved but remains weak compared to historic levels and could be tested further if interest rates continue to rise.

Risks

  • Continued stress in the banking sector.
  • Persistently elevated levels of inflation, which would warrant continued hawkish central bank policy, poses the most significant market risk.
  • A further escalation of the Russia-Ukraine conflict and the European energy crisis remains a possibility.

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

🟠

🔵

Equities have become more volatile as a result of stress in the global banking sector. The risks to financial stability make the path of monetary policy less certain than it appeared earlier in the year. Sentiment could also continue to be tested by more meaningful weakness in corporate earnings. Valuations are more supportive relative to recent history, particularly outside of the US. We remain underweight but we are looking for opportunities to add back to equity markets over the medium term.

Bonds

🔵

🔵

Government bonds have defensive characteristics in an uncertain economic environment and look more attractively valued relative to recent history. Within credit we continue to prefer higher quality securities with attractive yields which potentially offer strong risk-adjusted returns.

Alternatives

🔵

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.

Cash

🟠

Rising interest rates offer more attractive returns relative to recent history. Cash allows us to take advantage of tactical opportunities in potentially volatile markets.

Equities

Asset

Current positioning

Medium term view

Current views

Equities

🟠

🔵

Equities have become more volatile as a result of stress in the global banking sector. The risks to financial stability make the path of monetary policy less certain than it appeared earlier in the year. Sentiment could also continue to be tested by more meaningful weakness in corporate earnings. Valuations are more supportive relative to recent history, particularly outside of the US. We remain underweight but we are looking for opportunities to add back to equity markets over the medium term.

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. Whilst domestic companies face an uncertain backdrop, valuations are cheap and opportunities remain.

Europe

🟠



A mild winter has helped to reduce the near-term economic impact of the Russia Ukraine war and its disruption to energy supplies. 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

🟠


The failure of Silicon Valley Bank could led to slowing credit growth, increasing the probability of a US recession. At the same time, labour markets remain relatively resilient. Valuations remain elevated relative to other global equity markets while recent corporate earnings reports have been more mixed.

Japan

🟠

The reopening of both Japan’s international borders and the improved outlook for China could benefit the Japanese economy, however large cap exporters could face headwinds from a global recession. The Bank of Japan remain under pressure to tighten monetary policy, however it is likely to remain relatively supportive for risk assets in the near term.

Asia/ Emerging markets


🔵


🔵

The relaxation of China’s “Zero Covid” policies and earlier-than-expected reopening of the economy represents a significant economic support for China and the region more broadly. Equity markets have rallied in response, however valuations continue to be supportive and there remains the potential for further recovery after a challenging 2022.

Bonds

Asset

Curren positioning

Medium term view

Current views

Bonds

🔵

🔵

Government bonds have defensive characteristics in an uncertain economic environment and look more attractively valued relative to recent history. Within credit we continue to prefer higher quality securities with attractive yields which potentially offer strong risk-adjusted returns.

Government bonds

🔵


Valuations look more attractive given the sizeable yield moves we have seen over the past 12 months. UK gilts could benefit from a potential dovish shift in monetary policy as the Bank of England looks to support growth. We prefer shorter-maturity bonds at this stage, although could look to add longer-dated bonds to increase the defensiveness of portfolios.

Investment grade


🔵


🔵

Yields look attractive relative to other asset classes. 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. Opportunities remain within asset-backed securities which benefit from floating rate characteristics.

High-yield

🔵

Higher yields and shorter duration characteristics look attractive. Default rates remain low although face headwinds from a rising cost of debt, 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 rapid reopening of the Chinese economy and 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

🔵

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.

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 exposure to private companies. Valuations are relatively 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.

Equity-linked income strategies

Offer attractive returns especially in times of heightened volatility, but we acknowledge the shorter-term correlation with equities.

Gold

🔵

🟠

Gold can help to protect portfolios in the event of a meaningful equity market corrections or economic growth shocks. It may, however, 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.

Issued in the Channel Islands by Cazenove Capital which is part of the Schroders Group and is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission. 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

Cazenove Capital is a trading name of Schroders (C.I.) Ltd which is licensed under the Banking Supervision (Bailiwick of Guernsey) Law 2020 and the Protection of Investors (Bailiwick of Guernsey) Law 2020, as amended in the conduct of banking and investment business. Registered address at Regency Court, Glategny Esplanade, St. Peter Port, Guernsey GY1 3UF, (No.24546) . Schroders (C.I.) Limited, Jersey Branch is regulated by the Jersey Financial Services Commission in the conduct of investment business. Registered address at IFC1, Esplanade, St Helier, Jersey, JE2 3BX, (No.31076).

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