Snapshot

Views at a glance - October


September was the worst month of the year for global equities, but for now the pullback remains modest. The wobble has been caused by two concerns. Investors are worried about the prospect of higher borrowing costs, as bond yields rise from very low levels. There is also renewed anxiety about China’s property market – and in particular the fate of Evergrande, the country’s second largest developer. Markets are optimistic that a government-backed restructuring of the company’s $300 billion of liabilities will avoid a systemic shock. However, with the government focused on reducing debt across the sector, resolving the situation without some impact on growth could be challenging.

Central banks change tack

There has been a notable change in tone from central bankers in recent weeks, with policy makers acknowledging the risk that transitory inflation could turn into a more persistent phenomenon. The Federal Reserve has indicated that it may start winding down asset purchases as soon as next month, while the Bank of England surprised markets by suggesting it could raise interest rates early next year. Global energy markets have become the latest source of inflationary pressure. The short-term bottlenecks will ease, but the impact on prices could be felt for many months as shortages and disruption ripple through the global economy.

New leaders for Germany and Japan

Negotiations continue, but it now looks likely that Olaf Scholz of the SDP will emerge as the next Chancellor of Germany. The mooted “traffic light” coalition could accelerate some of the shifts that were already underway in Germany. This coalition would include the Green party, which won 15% of the popular vote, and would give greater priority to environmental issues. It may also take further steps towards looser fiscal policy and greater integration with the EU, both of which should be positive for eurozone growth. There is likely to be less change following Japan’s recent leadership contest: the new prime minister, Fumio Kishida, comes from the same party as his predecessor and has said he will make no immediate change to fiscal or monetary policy.

Portfolio positioning

We expect that the ongoing economic recovery and low interest rates will remain supportive of equity markets. We continue to see opportunities in longer-term themes, such as healthcare and technology, as well as more cyclical sectors as economies fully reopen. However, we may be heading towards a more volatile period for markets as growth momentum cools, inflation remains at somewhat elevated levels and central banks begin the process of normalising monetary policy. We therefore maintain our exposure to defensive and diversifying assets within multi-asset portfolios. We recently introduced a flexible credit fund with the ability to take a more defensive stance in times of market stress. We continue to see gold as an attractive hedge against inflationary tail risk, but it could come under pressure as yields rise.

Outlook

At-A-Glance-EXPORTS-Icon-625x626.png Economics
  • Above trend global growth in 2021 and 2022
  • Growth to be supported by elevated consumer spending and increasing capex
  • Economic activity data has peaked but remains at elevated levels
  • Monetary and fiscal policy remains supportive. Economic indicators are being closely monitored as US tapering begins
At-A-Glance-VALUATION-Icon-625x626.png Valuations
  • Bonds remain expensive but can provide some defensive ballast
  • Equities are expensive relative to their own historic averages, but should benefit from robust economic activity
  • Given the rich valuations of government bonds, alternative assets including absolute return funds look relatively attractive
At-A-Glance-SENTIMENT-Icon-625x626.png Sentiment
  • Investors remained concerned about persistently high inflation and threats to global growth
  • Sentiment indicators have moderated from extended levels
  • Volatility has risen above 5 year average levels
  • Investor cash levels have been trending down in recent months
At-A-Glance-RISKS-icon-625x626.png Risks
  • Signs of structurally higher inflation and potential for ‘taper tantrum’
  • Risk of further Covid variants and vaccine efficacy concerns
  • Impact of slowing growth in China and potential for further regulatory intervention
  • Risk of ‘stagflation’

Asset Classes

Equities At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Rolling vaccination programmes, alongside continued stimulus and earnings growth, have improved the outlook, but risks to global growth and earnings remain. We maintain our conviction in long-term secular themes including technology, health care and energy transition.
Bonds At-A-Glance-Status-Icons-NEGATIVE-50x50.png Valuations remain expensive, although government bonds provide some portfolio insurance characteristics. We prefer US and Chinese government bonds due to relatively higher yields and diversification benefits. We prefer corporate and inflation-linked bonds to conventional government bonds.
Alternatives At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Attractive diversification characteristics compared with equities and bonds. We favour absolute return strategies with the ability to deliver less correlated returns as well as real assets with long-dated visible revenue streams.
Cash At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Cash has defensive qualities in potentially volatile markets.

Equities

Equities At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Rolling vaccination programmes, alongside continued stimulus and earnings growth, have improved the outlook, but risks to global growth and earnings remain. We maintain our conviction in long-term secular themes including technology, health care and energy transition.
UK At-A-Glance-Status-Icons-NEUTRAL-50x50.png Supply chain disruption resulting from both Covid and Brexit may cause near-term headwinds. We continue to see select opportunities, which will be supported as vaccine rollouts continue and restrictions are lifted.
Europe At-A-Glance-Status-Icons-NEUTRAL-50x50.png The growth outlook remains positive for the rest of the year, although political uncertainty (German election result) and ongoing supply chain disruption pose headwinds. Policy is supportive and earnings remain robust.
North America At-A-Glance-Status-Icons-NEUTRAL-50x50.png US equities continues to be supported in the near term by monetary policy and robust earnings growth. We are watchful of valuations which remain elevated, as well as potential disruption from political gridlock.
Japan At-A-Glance-Status-Icons-NEUTRAL-50x50.png Swift progress in vaccine rollout programmes and a gradual relaxation of restrictions should support domestic companies as activity improves. Exporters face near term headwinds as a result of global supply chain bottlenecks and growth concerns.
Asia Pacific At-A-Glance-Status-Icons-NEUTRAL-50x50.png Restrictions continue to weigh on economic activity in parts of the region in the near term. Slowing Chinese growth and a weakening credit impulse may have broader implications for the region.
Emerging markets At-A-Glance-Status-Icons-NEUTRAL-50x50.png Recent regulatory intervention from Chinese authorities, concerns over slowing growth and the risk of contagion from the Evergrande Group crisis have weighed on sentiment in the near term. Cyclical rotation is supportive for the region as a whole.

Bonds

Bonds At-A-Glance-Status-Icons-NEGATIVE-50x50.png Valuations remain expensive, although government bonds provide some portfolio insurance characteristics. We prefer US and Chinese government bonds due to relatively higher yields and diversification benefits. We prefer corporate and inflation-linked bonds to conventional government bonds.
Government bonds At-A-Glance-Status-Icons-NEGATIVE-50x50.png Long-dated government bonds provide portfolio insurance characteristics, despite the risk of rising inflation. US Treasuries and Chinese government bonds offer relatively more attractive real yields.
Investment grade At-A-Glance-Status-Icons-NEUTRAL-50x50.png We are mindful of company leverage, spreads below pre-Covid levels and absolute yields at close to all time lows. Central bank action and fiscal policy remain supportive for the asset class. We see opportunities within asset-backed securities, which offer a relatively attractive yield.
High-yield At-A-Glance-Status-Icons-NEUTRAL-50x50.png Spreads remain at below pre-Covid levels. Default rates remain supported by central bank action, the low cost of debt and expected positive economic growth in the short term.
Inflation-linked At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png We prefer US TIPS to conventional treasuries and UK linkers given the reduced cost of currency hedging. Inflation expectations have the potential to move higher in response to supply chain concerns and energy prices.
Emerging markets At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Emerging market bonds offer selective value across both US dollar and local currency debt. Idiosyncratic country risk remains diverse and a significant driver of returns.

Alternatives and cash

Alternatives At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Attractive diversification characteristics compared with equities and bonds. We favour absolute return strategies with the ability to deliver less correlated returns as well as real assets with long-dated visible revenue streams.
Absolute Return At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Selected opportunities in market-neutral strategies given increased stock dispersion and diversification characteristics.
Liquid private real assets 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 and exposure to private companies.
Gold At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Gold is attractive as a diversifier given loose monetary policy, and should provide portfolio insurance in the event of a meaningful equity market correction, or inflationary shock.
Structured products At-A-Glance-Status-Icons-POSITIVE-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 Cash has defensive qualities in potentially volatile markets.

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 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.