Views at a glance – November 2023
The US economy was surprisingly strong in the third quarter and inflation continues to fall. But investors are starting to worry they may have less reason for cheer in 2024.
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Markets remain volatile
Conflict in the Middle East has not helped investor sentiment over the past month. However, the decline we have seen in stock markets in recent weeks probably owes more to volatility in bond markets and continued concern about the impact of higher interest rates on growth. In the US, the 10-year Treasury yield briefly breached the key psychological level of 5% for the first time since 2007, before ending October below this level. Major central banks left rates on hold at their latest meetings, suggesting that they are becoming more confident about the path of inflation. However, this positive development is being somewhat overshadowed by growing concern over supply and demand dynamics in government bond markets. Given high levels of government debt around the world, this could remain a source of volatility for some time.
Is this as good as it gets for the US economy?
Early figures suggest that the US economy grew at an annualised rate of 4.9% in the third quarter, the strongest performance since late 2021. The data suggests that a "soft landing" – lower inflation without a recession – is becoming a reality. Given that this outcome has been increasingly anticipated, however, the news did little to help markets. The US economy is likely to continue expanding, but markets are increasingly focused on future growth headwinds. These include the end of a moratorium on student loan repayments (introduced during the pandemic) as well as the continued possibility of a government shutdown. Consumer spending could also slow from current, strong levels. The personal savings rate is now below average, suggesting that households may soon need to cut back on spending and start rebuilding reserves.
What conflict in the Middle East could mean for the world economy
The complicated geopolitics of the Middle East unfortunately mean there is a risk of the conflict expanding. This could lead to disruption in energy markets, with potentially significant consequences for the global economy. As we saw following the invasion of Ukraine, sudden increases in energy prices have a "stagflationary" impact, depressing growth and raising inflation. In the US, core inflation, which excludes the impact on commodity prices, has fallen to just over 4% from around 6.5% a year ago. While energy prices have little direct impact on core inflation, central bankers will be worried about the “second round effect” of wages rising in response to higher prices. Given that employment markets remain tight, this could lead to further rate rises and delay any pivot to rate cuts. This would add to the pressure on consumers from higher commodity prices, undermining a key driver of developed market economies.
Portfolio positioning
A peak in interest rates and a continued decline in inflation are two of the key signals we were looking for before turning more positive on equities. It looks increasingly likely that the first condition has been met and there has been significant progress on the second. We have therefore taken advantage of the recent de-rating in equity markets to slightly increase our equity exposure across risk mandates. For now, however, we remain underweight the asset class. This reflects our view that economic growth is slowing as the full impact of rate rises to date is felt. We are comfortable with our modest overweight position in government bonds. Bonds now offer attractive levels of income and could start to offer greater diversification benefits if the global economy slows more meaningfully. We continue to see the appeal of alternatives, which could provide valuable diversification benefits if inflation were to rise again. 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 |
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Valuations |
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Sentiment |
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Risks |
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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 but have been using market weakness as an opportunity to increase exposure. Corporate earnings have been relatively robust in the latest reporting season, though forward earnings estimates may be overoptimistic. While valuations remain expensive relative to history, the recent selloff means they are more attractive than they were at the start of the year. A deterioration in investor sentiment is supportive as it suggests markets are “pricing in” a more realistic economic outlook. |
Bonds | 🔵 | 🔵 | Nominal government bonds have defensive characteristics in an uncertain economic environment and yields look more attractive relative to recent history. We have gradually lengthened interest rate duration this year as we move closer to the end of the rate cycle. However, we continue to prefer shorter duration assets overall. Elsewhere, we continue to prefer the credit of higher quality issuers as well as emerging market debt where growth prospects are brighter. |
Alternatives | 🔵 | ⚪ | Alternatives continue to offer attractive diversification characteristics in a potentially volatile environment. Within absolute return we favour strategies with the ability to deliver less correlated returns. We remain positive on real assets with long-dated, visible revenue streams and commodities where supply and demand dynamics could support prices over the medium term. |
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 but have been using market weakness as an opportunity to increase exposure. Corporate earnings have been relatively robust in the latest reporting season, though forward earnings estimates may be overoptimistic. While valuations remain expensive relative to history, the recent selloff means they are more attractive than they were at the start of the year. A deterioration in investor sentiment is supportive as it suggests markets are “pricing in” a more realistic economic outlook. |
UK | ⚪ | 🟠 | The UK economic outlook remains challenging. Inflation continues to prove resilient especially as wage growth reaches record highs, so we expect it to remain elevated in comparison to recent history. The UK consumer could remain under pressure with “higher for longer” interest rates and sentiment may continue to weaken. While domestic companies face an uncertain backdrop and are pricing in more downside risk, valuations are supportive, and opportunities remain. |
Europe | 🟠 | ⚪ | Valuations in Europe have exceeded their long-term median and earnings expectations seem overly optimistic given the probability of a slowdown in the second half of the year. Further cracks are beginning to emerge amidst slowing retail sales, manufacturing and services. |
North America | 🟠 | ⚪ | In the US, resilient consumption and a peak in interest rates have reduced the probability of a “hard landing” in the near term. Market leadership has been narrow, focussed on a small number of large cap technology companies particularly those with AI-related revenues. More recently, there have been signs that market leadership is broadening out, which could suggest a more sustainable recovery. Corporate earnings are holding up and a recent pullback has left valuations looking more supportive, although still expensive. |
Japan | 🔵 | 🔵 | Japanese earnings have continued to be a bright spot, whilst valuations remain attractive despite strong equity market performance this year. Whilst the Bank of Japan are gradually dropping Yield Curve Control, monetary policy remains loose relative to other developed countries. Corporate governance reforms are supportive over the medium term. |
Asia/ Emerging markets |
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| In China, falling domestic consumption and troubles in the property sector have led to a deterioration in economic data this year; however, investor sentiment is at extreme lows and valuations are cheap. Elsewhere, growth prospects look more robust but remain highly dependent on the global cycle while valuations also remain reasonable relative to history. |
Bonds
Asset | Curren positioning | Medium term view | Current views |
Bonds | 🔵 | 🔵 | Nominal government bonds have defensive characteristics in an uncertain economic environment and yields look more attractive relative to recent history. We have gradually lengthened interest rate duration this year as we move closer to the end of the rate cycle but continue to prefer shorter duration assets overall. Elsewhere, we continue to prefer the credit of higher quality issuers as well as emerging market debt where growth prospects are brighter. |
Government bonds | 🔵 | ⚪ | Yields look more attractive given the sizeable 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 market pricing of future central bank policy changes. |
Investment grade | ⚪ | 🔵 | Absolute yields continue to look attractive, although spreads are less supportive at current levels. We prefer shorter-duration and higher-quality credit in the near term given uncertainty around corporate earnings and the shape of the credit curve, 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, and potential for weakening earnings. In the event that spreads widen, it could provide opportunities to increase exposure. |
Inflation-linked | 🔵 | ⚪ | Valuations are looking more attractive with US real yields in particular continuing to rise and firmly in positive territory. US breakeven levels remain low and inflation linked bonds continue to offer a hedge against more persistent inflation witnessed within developed markets. |
Emerging markets | 🔵 | 🔵 | Emerging market growth prospects excluding China look relatively robust compared to Developed Markets whilst central banks have recently been cutting rates. The potential for further USD weakness remains and would be supportive for the asset class. Valuations are attractive relative to other credit markets. |
Alternatives and cash
Asset | Current positioning | Medium term view | Current views |
Alternatives | 🔵 | ⚪ | Continue to offer attractive diversification characteristics in a potentially volatile environment. Within absolute return we favour strategies with the ability to deliver less correlated returns. We remain positive on real assets with long-dated, visible revenue streams and commodities where supply and demand dynamics could support prices over the medium term. |
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 |
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| 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 |
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| Broader commodities can hedge against further disruption to energy markets, although areas of the asset class are sensitive to slowing economic growth particularly in China. Longer term, increasing demand from energy transition could support industrial metal prices against a backdrop of tight supply. |
Equity-linked income strategies | ⚪ | ⚪ | These 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 economic growth or an inflation 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.
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.
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