Monthly Investment Outlook – August 2023
Author: Jonathan Unwin, Asset Management & Advisory.
With the Federal Reserve (and indeed the markets) now expecting a ‘soft landing’, i.e. a scenario where inflation moderates without upending the wider economy, investors may be forgiven for feeling far more relaxed about the prospects for their assets than at any point over the past 18 months.
Though price indices remain higher and stickier than expected there is little doubt that inflation is now moving in the right direction and appears to have peaked in all developed economies, and (forward-looking) equities in particular are reflecting this. In under 20 months, the pandemic’s bear market that rocked the stock market is nearly wiped out with most of 2022’s losses recovered. Volatility in stocks has once again dropped back to extreme lows, as the years’ earlier banking crisis and US debt ceiling imbroglio now seem firmly in the rear-view mirror, with financial markets taking a leap of faith, discounting a sharp bounce in economic activity, for which there is little evidence.
Markets are even pricing in a rate cut in the US by the end of the year, which looks especially optimistic, and would require a sustained period of strong data that does not seem forthcoming at this point. Employment, globally, remains robust and while this is the case any recession will be largely technical rather than acutely felt by the consumer, although paradoxically a strong jobs market may prolong higher inflation. Equity valuations have crept back up to expensive levels, led by the continuing mania for AI stocks, but these valuations are by no means even and away from the leader-board many cheap opportunities exist for the patient investor.
While we are not convinced that the equity bear-market has concluded, we accept that there does not seem to be cause for an imminent crash, and there ample pockets of value across the asset-class spectrum that allow us to be near fully invested.
The market is pricing in a soft-landing for the global economy, but earnings and valuations are increasingly detached from fundamentals.
Yields on quality investment grade bonds mean we are more comfortable holding a neutral allocation in fixed income, but we remain cautious on duration while inflation lingers.
Precious metals compliment equities and bonds, while a selection of hedge fund strategies can offset both asset classes in time of volatility and market stress.
Central Bank Rates
|Country||Current rate||3 Months||6 Months||9 Months||Peak|
|US||5.33||5.44 ↑||5.35 ↑||5.08 ↑||5.44|
|EU||3.58||3.80 ↑||3.79 ↑||3.75 ↑||3.70|
|UK||4.93||5.71 ↑||5.83 ↑||5.83 ↑||5.83|
|JAPAN||-0.07||-0.05 ↓||-0.04 ↓||-0.04|
Our sub-asset class views
|EQUITIES||GGGG||The gap between earnings expectations and fundamental economic health has widened, suggesting stocks have got ahead of themselves. Top line valuations are stretched, but there is plenty of value to be found.|
|US||RRRR||RRRR||The US tech sector and hype surrounding the potential of AI has dragged the market higher, with most index constituents treading water as recession looms.|
|UK||GGGG||British stocks are still very cheap and GBP appreciation attractive for EUR, USD investors. Growth revised up, but tepid. Wage inflation a problem.|
|Eurozone||GGGG||Reasonable valuations and solid earnings outlook are tempered by high inflation and mediocre growth outlook. Germany in recession, but region could benefit from China stimulus.|
|Switzerland||GEGE||GEGE||Quality, defensive nature of the market continues to see Swiss stocks in demand, though valuations relatively rich now.|
|EM||GGG||China looks to receive more stimulus as reopening fizzles out, but this may not transpire into equity gains. Other Asian economies look set to benefit from Western ‘friendshoring’.|
|Japan||GEGE||GEGE||Attractive valuation for a developed market, with a lower yen supporting its export sector. Economy currently humming. Appreciating JPY should offset QT for foreign investors.|
|FIXED INCOME||GGGG||The cloudy inflation outlook precludes us from being over-optimistic towards bonds, but with yields more normalised and economic slowdown looming, an upgrade to a neutral weighting is justified.|
|Sovereign Bonds||GGGG||We prefer Treasuries to Bunds and Gilts as the Fed appears nearer to cuts than the BOE or ECB. Economic slowdown should provide demand.|
|Corporate I.Grade Bonds||GEGE||GEGE||Short duration high quality IG yielding 5/6% is appealing as the core of a bond portfolio. Duration’s time will come, but not yet.|
|High Yield Bonds||GGGG||Default rates are subdued, but may rise as financing costs increase. Yields look attractive, but highly selective approach needed.|
|E.M. Bonds||GGGG||We are generally cautious on emerging markets given looming recession fears, but our short duration approach achieves yield at acceptable risk.|
|ALTERNATIVES||GEGE||GEGE||We like holdings that are genuinely uncorrelated to the main asset classes.|
|Precious Metals||GEGE||GEGE||Gold is well supported as rate expectations peak. Remains the most compelling long-term hedge against inflation and elevated geopolitical risk.|
|Hedge Funds||GEGE||GEGE||GEGEAAA||Genuine alternative funds that behave in a different manner to traditional assets are a vital source of wealth preservation and diversification.|
|Oil/Commods||GEGE||GEGE||2022’s spike has receded but shifting geopolitics and green policies will offer structural upside over the longer term.|
|CURRENCIES||Currencies are largely following the trajectories of their respective central banks, which points to a weaker Dollar, all else being equal.|
|U.S. Dollar (DXY)||RRRR||RRRR||The dollar is only likely to retreat further if lower inflation trend is confirmed and FED becomes more dovish. Likely to be underpinned by relative resilience of US economy v Europe.|
|Sterling (GBP)||GEGE||GEGE||A period of political calm and a hawkish BOE are supporting the pound, and economic data has once again been revised modestly upwards.|
|Euro (EUR)||GGGG||Has rallied on ECB hike, China and sticky inflation. Economy looks vulnerable to consumer squeeze and ECB will be wary of hiking too hard in face of recession.|
|Japanese Yen (JPY)||GEGE||GEGE||GEGEAAA||JPY has potential to significantly breakout when and if BOJ loosen curve control. For now loose monetary policy remains.|
|Swiss Franc (CHF)||GGGG||CHF looks well set, with the prospect of incremental higher rates and the UBS takeover of CS now in the rarview mirror.|
|EM||GEGE||GEGE||China stimulus and the first rate cut in some years may hold CNY back. Other EMFX’s may do well as the Dollar weakens.|