Snapshot

Views at a glance – October 2022


The bear market is back

Stock and bond markets are once again under pressure, leaving investors with few places to hide. US equities experienced their worst September in 20 years and ended the month 25% lower, in USD terms, than at the start of the year (but only 8% lower in GBP). Bonds have also performed poorly. The sell-off has been particularly brutal in the UK, as investors have reacted badly to the new government's approach to spending and borrowing. In the first nine months of the year, UK government bonds fell 25%. However, we have seen a similar trend in many other bond markets around the world as an era of exceptionally low-interest rates comes to an end. High levels of volatility may be with us until investors have a better sense of when interest rates will stop rising – and the level at which they settle.

UK shows that debt and deficits still matter

Last month, it looked as if soaring energy prices would be the greatest near-term headwind for the UK economy. But Chancellor Kwasi Kwarteng’s “mini-budget” included a generous support package to limit the impact for households and businesses – and that on its own might have been palatable to markets. Instead, the challenge has come from Downing Street’s unexpected tax cuts and the apparent absence of any plan to bring government debt back down. Intervention by the Bank of England and a tax cut “u-turn” have undone some of the damage, but sterling and UK markets remain volatile. Investors now expect UK interest rates will need to rise further to offset the inflationary impact of the mini-budget. However, as the last two weeks have shown, rapid rises in interest rates come with significant risks to economic and financial stability. The Bank of England may have to accept higher UK inflation as the lesser evil.

Can Ukraine win the war?

Ukrainian forces have recovered significant amounts of lost territory in recent weeks and have made further advances in early October. Their success at least raises the possibility that Ukraine may be able to repel the Russian invasion, something that looked unimaginable earlier in the year. Russia has responded by calling for a partial mobilisation and reiterating its threat to use nuclear weapons. The risks of dramatic escalation cannot be ruled out. At the same time, recent developments could encourage Putin to look for a way out of a war that it appears he can no longer win. While it does not look imminent, a resolution of the conflict and the restoration of European gas supplies would be a huge shot in the arm for the global economy. 

Portfolio positioning

As we move into the fourth quarter, we expect developed market central banks to maintain their hawkish stance and further raise interest rates. This is likely to lead to recessions in the UK, US and eurozone and we could see corporate earnings start to decline over the remainder of the year. In this environment, we remain underweight equity, with a clear preference for higher-quality companies. Government bond valuations now look more attractive and we are starting to gradually increase our exposure. We are also modestly increasing our allocation to alternative investments, which we continue to like as a source of diversification. We retain our significant exposure to the US dollar, which should provide some protection in more challenging environments.

Outlook

At-A-Glance-EXPORTS-Icon-625x626.png Economics
  • An uncertain outlook with slowing economic growth and rising risk of recession.
  • Lower commodity prices and fewer supply chain disruptions could see US inflationary pressures ease.
  • US labour market remains strong, although signs of weakness are starting to appear.
  • UK economic and inflation outlook remains uncertain following recent political developments.
  • Interest rates are likely to continue to rise in the near term.
At-A-Glance-VALUATION-Icon-625x626.png 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 rises.
  • Alternative assets including absolute return funds and commodities look attractive as diversifiers.
At-A-Glance-SENTIMENT-Icon-625x626.png Sentiment
  • The direction of monetary policy and the risk of recession are likely to continue to test sentiment.
  • Ongoing political and geopolitical uncertainties may also weigh on sentiment.
  • Consumer confidence remains close to all-time lows and business optimism surveys are weak.
At-A-Glance-RISKS-icon-625x626.png Risks
  • A monetary policy induced 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 and a European energy crisis.

 

Asset Classes

 Asset classes Current positioning Medium term view Current views
Equities At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-UP-50x50.png Equities could remain under pressure as higher interest increase the risk of recession and a decline in corporate earnings. We remain underweight and continue to prefer higher-quality companies which can better navigate a more challenging environment. Over the medium term, signs that US interest rates have peaked and earnings have stopped being downgraded could support a move to increase exposure.
Bonds At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-UP-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-UP-50x50.png Nominal government bonds have defensive characteristics in a more challenging macro-economic environment and look more attractively valued relative to recent history. We prefer US treasuries, which benefit from a higher level of certainty around the path of monetary policy. 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 At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png    At-A-Glance-Status-Icons-DOWN-50x50.png 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 At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-DOWN-50x50.png At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png    At-A-Glance-Status-Icons-DOWN-50x50.png 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 At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-UP-50x50.png Equities could remain under pressure as higher interest increase the risk of recession and a decline in corporate earnings. We remain underweight and continue to prefer higher-quality companies which can better navigate a more challenging environment. Over the medium term, signs that US interest rates have peaked and earnings have stopped being downgraded could support a move to increase exposure.
UK At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   Investor sentiment on domestic UK equities remains weak given concerns over an expanding fiscal deficit, and the implications for inflation, interest rates and sterling. Volatility is likely to remain elevated as political uncertainty continues. Valuations are now cheap relative to recent history.
Europe At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   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 At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png   The US economy has the potential for greater self-sufficiency in both energy and agriculture and is therefore more insulated from geopolitical unrest. Further interest rate rises are likely whilst inflation remains elevated and the labour market remains robust. Consumer sentiment remains close to all-time lows and business optimism is weak. However, valuations have moderated to below 15 year averages.
Japan At-A-Glance-Status-Icons-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png Lower risk of inflation, more fiscal support combined with accommodative monetary policy could lead to improved domestic economic growth driven by consumption. Weakness in the Yen is putting increasing pressure on the Bank of Japan to amend policy.
Asia/
Emerging markets
At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png   In the near term, investor sentiment continues to be tested by uncertainty around China’s property sector and the potential for further restrictions under China’s “Zero Covid” policy. However, monetary policy is becoming more supportive, there is the potential for greater fiscal spend to support growth and valuations remain attractive relative to 15-year averages.=.

 

Bonds

Asset Current positioning Medium term view Current views
Bonds At-A-Glance-Status-Icons-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-UP-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-UP-50x50.png
Nominal government bonds have defensive characteristics in a more challenging macro-economic environment and look more attractively valued relative to recent history. We prefer US treasuries where we feel there is more certainty around the path of monetary policy. 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 At-A-Glance-Status-Icons-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-UP-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-UP-50x50.png 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 where we feel there is more certainty around the path of monetary policy. We prefer shorter maturity bonds at this stage, although could look to lengthen duration to add further defensiveness to portfolios.
Investment grade At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-UP-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png Yields look attractive relative to other asset classes. 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 benefit from floating interest rates, which are more appealing in a rising interest rate environment.
High-yield At-A-Glance-Status-Icons-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png 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 At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png   The potential for more persistent inflationary pressures could keep inflation expectations elevated relative to recent history. Valuations are looking more attractive following the rise in real yields we have seen this year.
Emerging markets At-A-Glance-Status-Icons-NEGATIVE-50x50.png   At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png   Certain emerging markets could see near-term balance sheet deterioration as a result of a more uncertain global economic backdrop and continued Covid headwinds. Valuations are supportive and there are select opportunities across both US dollar and local currency debt.

 

Alternatives and cash

Asset Current positioning Medium term view Current views
Alternatives At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-DOWN-50x50.png 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 At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png   At-A-Glance-Status-Icons-DOWN-50x50.png 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 At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-UP-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png 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 exposure to private companies. Valuations are attractive following recent market volatility.
Commodities At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Broader commodities can hedge against further rises in inflation although areas of the asset class are sensitive to slowing economic growth. Longer term, increasing demand from energy transition could support prices.

Equity-linked income strategies At-A-Glance-Status-Icons-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEUTRAL-50x50.png Offer attractive returns especially in times of heightened volatility, but we acknowledge the shorter-term correlation with equities.

Cash At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png  At-A-Glance-Status-Icons-DOWN-50x50.png Gold should provide portfolio insurance in the event of a meaningful equity market correction or economic growth shock although could face headwinds from rising real yields.
 



Key

At-A-Glance-Status-Icons-POSITIVE-50x50.png Positive
At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Positive/neutral
At-A-Glance-Status-Icons-NEUTRAL-50x50.png Neutral
At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Negative/neutral
At-A-Glance-Status-Icons-NEGATIVE-50x50.png Negative
At-A-Glance-Status-Icons-UP-50x50.png Up from last month
At-A-Glance-Status-Icons-DOWN-50x50.png 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.

This article is issued by Cazenove Capital which is part of the Schroder 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.

Contact Cazenove Capital

To discuss your DFM requirements, or to find out more about our services and how we can help you, please contact:

Nick Georgiadis

Nick Georgiadis

Former Head of DFM Team nick.georgiadis@cazenovecapital.com
Simon Cooper

Simon Cooper

Head of DFM Relationship Management simon.cooper@cazenovecapital.com