Views at a glance – October 2023
Equities and bonds have both been under pressure as interest rates look set to remain “higher for longer”.
A plateau rather than a peak in interest rates
For most of this year, equity markets have been rising while government bonds have been drifting lower. This traditional relationship came under pressure in September, as both equities and bonds fell together in an unwelcome reminder of 2022. The shift appears to have been driven by a rising awareness that interest rates will need to remain high for some time to bring inflation back to target – more “Table Mountain than the Matterhorn,” as the Bank of England’s Chief Economist memorably put it. Higher commodity prices, especially oil, have also been fueling concern about inflation and interest rates. On a total return basis to the end of September, global equities are down 6.5% from their peak. The weakness in sterling has limited the drawdown in GBP terms to just -2.6%.
US dodges another crisis, but government debt remains a worry
Investors have also been concerned by congressional wrangling over the US budget. An eleventh-hour agreement has averted the risk of a government shutdown, but only for 45 days, raising the prospect of another battle later in the year. While a shutdown would have been a headwind to growth, it is far from unprecedented; it has occurred 10 times in the past 40 or so years. However, the episode comes just months after similar brinksmanship over the US debt-ceiling and is a reminder of the risk and uncertainty that can come with high levels of debt and large deficits. It was almost exactly a year ago that the UK government found itself in a stand-off with the bond markets over its fiscal plans. More recently, European bond markets have been under pressure amid concern about a larger-than-expected Italian budget deficit.
A multi-speed world
The latest US data generally points to an economy that is slowing but still expanding. Figures from China and Europe paint a different picture. Schroders’ economists have cut their expectations for Chinese growth this year to 4.8%, almost two percentage points lower than at the start of the year. Over the coming months, we expect to see further support measures from Beijing, but not the kind of “shock-and-awe” stimulus that we have seen in the past. The weakness has been spilling over into Europe, where activity has also been hampered by high energy prices. As a relatively self-sufficient economy, the US is insulated from some of these challenges. However, very sluggish growth in significant parts of the world economy puts more pressure on the US consumer as the engine of global growth.
Portfolio positioning
US inflation continues to fall while its economy remains relatively resilient. We are therefore taking advantage of the recent de-rating in equity markets to slightly increase our exposure across risk mandates. Importantly, we remain underweight equity compared to our long-term strategic allocation. This reflects our view that economic growth is slowing and that it is too soon to declare victory against “sticky” core inflation. 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 believe that alternatives have an important role to play in portfolios. Our view that many UK alternative investment companies are undervalued has been supported by recent corporate activity in the sector.
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 in the near term, although we continue to look for opportunities to increase exposure. Corporate earnings have been relatively robust in the recent reporting season. Valuations have re-rated driven by stronger investor sentiment and are less attractive than they were at the start of the year. Market leadership has been narrow this year, particularly in the US, focused on large cap technology companies. |
Bonds | 🔵 | 🔵 | Government bonds have defensive characteristics in an uncertain economic environment and yields look more attractive relative to recent history. We have continued to gradually lengthen interest rate duration as we move closer to the end of the rate hiking cycle. 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 | ⚪ | 🟠 | Higher interest rates mean cash offers more attractive returns than it has for many years. It also allows us to take advantage of tactical opportunities 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. Corporate earnings have been relatively robust in the recent reporting season. Valuations have re-rated driven by stronger investor sentiment and are less attractive than they were at the start of the year. Market leadership has been narrow this year, particularly in the US, focused on large cap technology companies. |
UK | 🔵 | 🟠 | The UK economic outlook remains challenging. Inflation is proving resilient as wage growth reaches record highs. UK consumers could face further pressure if interest rates continue to rise and sentiment may continue to weaken. While domestic companies face an uncertain backdrop and are pricing more downside risk, valuations are supportive and opportunities remain. |
Europe | 🟠 | ⚪ | Valuations in Europe have surpassed their long-term median and earnings expectations seem overly optimistic in the event of slowdown in the second half of the year. Furthermore, cracks are beginning to emerge amidst a slowdown in retail sales, manufacturing and services. |
North America | 🟠 | ⚪ | US equities have performed well as resilient consumption and a likely peak in the interest rate cycle reduce the probability of a hard landing in the near term. Market leadership has been narrow, focused on a small number of large cap technology companies, particularly those with AI-related revenues. More recently, there have been signs that leadership is broadening, potentially signalling a more sustainable recovery. After this year’s rally, valuations look less supportive, although in the near-term corporate earnings are holding up. |
Japan | 🔵 | 🔵 | The widening of the Bank of Japan’s Yield Curve Control bands remove some policy uncertainty. In addition, equity valuations remain attractive and a greater focus on corporate reform is supportive over the medium term. |
Asia/ Emerging markets |
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| Weak domestic consumption and difficulties in the property sector have led to a sharp deterioration in economic data. Further stimulus may be needed to improve investor sentiment. Elsewhere in Asia and emerging markets, growth prospects look more robust but remain highly dependent on the global cycle. Valuations remain reasonable. |
Bonds
Asset | Curren positioning | Medium term view | Current views |
Bonds | 🔵 | 🔵 | Government bonds have defensive characteristics in an uncertain economic environment and yields look more attractive relative to recent history. We have continued to gradually lengthen interest rate duration as we move closer to the end of the rate hiking cycle. 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, adding 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 so at current levels. We prefer shorter-duration and higher-quality credit in the near term given uncertainty around corporate earnings. We may 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. US real yields continue to rise and are now 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. 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 | 🔵 | ⚪ | 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 interesting opportunities in renewables, 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. However, there is a shorter-term correlation with equities. |
Gold | 🔵 | ⚪ | Gold can help to protect portfolios in the event of an economic growth or an inflation shock and benefit from USD weakness. However, it continues 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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