Inview August 2023

Editorial

Welcome to the August edition of Inview: Monthly Global House View. In this publication we consider significant developments in the world’s markets, and discuss our key convictions and themes for the coming months.

After a strong June, markets enjoyed another positive month in July with the MSCI World index rising around 2% over the month. Global equities have now returned more than 16% year-to-date and are close to recouping the losses experienced in 2022. Fixed income markets also mostly registered positive returns in July. The Bloomberg Barclays Global Aggregate index was up about 1% for the month, though the year-to-date returns are significantly more muted than equities at just over 2%.

The strong performance in July reflects a macroeconomic environment in which activity has remained stronger than expected and recession fears have abated. The IMF’s World Economic Outlook update pointed to near-term resilience as it upgraded its GDP growth forecasts for 2023. Furthermore, headline inflation has rolled over, reflecting the mechanical impact of base effects due to high inflation in 2022, as well as declines in energy prices. However, core inflation has remained more persistent.

Markets have also taken note of favourable developments on the policy side. Despite core inflation’s persistence, central banks appear to be close to the end of monetary policy tightening cycles. In addition, China’s Politburo meeting concluded with recognition of the need to support domestic demand, though no specific measures were announced to do so.

The implications for the asset allocation of a diversified portfolio are that, in our view, maintaining moderate overweights in both equities and fixed income assets remains justified. Within equities, a preference remains for emerging markets and, in particular, Asia and Latin America. Japanese equities are also favoured and an underweight allocation to the US is retained to offset the overweights.

Within fixed income assets, longer-dated government bond yields continue to be attractive given monetary policy cycles are drawing to a conclusion and the diversification benefits. With the potential for the lagged impact of interest rate increases to cause a deterioration in the macroeconomic environment, a preference for high quality fixed income assets continues to be appropriate. This means that overweight allocations to investment grade and sovereign bonds remain funded by an underweight allocation to high yield bonds.

Asset Allocation

Global Allocation

The general macroeconomic environment continues to show disparities between leading and lagging indicators. Backward looking data continues to appear strong while forward looking data is weaker, with this juxtaposition helping explain market behaviour. One of the main risks of the coming months would be if core inflation remains too high, something which could lead to more volatile markets.

No changes were made to our allocations to the broad asset classes apart from adjustments taking into account the new neutral benchmark and market drift. We maintain a slight overweight allocation to equities and also a small overweight in fixed income. Underweights to alternatives and cash also remain. Hedging using put spreads is currently cheap relative to history although we would wait for the VIX volatility index to move a point or two lower before considering implementing outright hedges on portfolios. The potential rewards from implementing a hedge need to be weighed carefully against the premium cost.

Fixed Income

Within the fixed income market, returns have been less pronounced than that of equities. Absent a sharp recession and dramatic unexpected improvement in the inflation outlook, it appears difficult for yields to rebound meaningfully. Nevertheless, year-to-date performance has been positive apart from for the UK.

Investment grade spreads appear relatively more attractive than high yield spreads in the US. The spread to worst of the ICE BofA US High Yield Index is close to its lower quartile while that of the Corporate Index appears in line with its median. The picture appears slightly better in terms of spreads for European and UK bonds.

Having duration exposure within fixed income provides a hedge against a deterioration in the macroeconomic environment. We maintain a bias to 5-7 years duration for the higher quality part of the market. Within high yield our preference would be at the shorter end of the curve which is less exposed to macro risks but could produce an attractive yield pick-up.

Equities

Absent any major market catalysts, we made no changes to our equity exposure. After their strong performance in the first half of the year, Japanese equities have seen a slower start to July. However, we continue to favour the market and expect a resumption of momentum. Our valuation models indicate that China has become relatively cheaper compared to June. We continue to have an overweight China allocation versus the benchmark, noting that any rebound in the market is likely to be front-loaded.

UK and Europe positioning continues to be in line with the neutral benchmark, supported by positive valuations and technicals offset by a more vulnerable macro situation. US positioning is underweight relative to the benchmark, although the absolute weighting dominates the equity exposure and we note growing odds of a soft landing scenario in the US.

Alternatives

No changes were made to our alternatives exposure this month. Commodity positioning is neutral with a focus on gold. Indicators are currently pointing to a potential bottom for commodity prices although we will wait for confirmation of this trend in the second half of the year before adding exposure to industrial metals. We remain cautious on the real estate sector owing to liquidity concerns.

Within hedge funds, heightened volatility stemming from uncertainty in inflation and rates should be supportive for equity market neutral managers. Similarly, commodity trading advisor strategies are preferred in the context of more market volatility.

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