Macroeconomy
There is a wide divergence between strong purchasing-manager index (PMI) data for services and much weaker data for manufacturing, particularly in advanced economies. With declines in order backlogs and the increase in inventories in goods industries are pointing to an end to the economic cycle, we expect relatively modest global GDP growth of 2.6% this year. Growth in the US is set to fade, with the possibility of recession in H2. While the fed funds rate may have peaked, we still do expect any rate cuts from the Fed this year. Growth in the euro area is also set to slip, although we believe it may avoid recession. We expect a further 25 bps rate hike from the European Central Bank in mid-June given still-strong inflation. Although we are maintaining our 2023 forecast for GDP growth at 5.5% for now, China’s recovery has been losing momentum, possibly paving the way for stronger policy support in the months ahead. Japan is on course for moderate growth this year (our forecast is 1.3% GDP growth), driven essentially by a domestic recovery. But we e do not expect any drastic changes in Bank of Japan policy in the near term.
Asset classes
Equities Although May was hardly memorable for equity returns in developed markets overall, US tech and Japanese stocks strode ahead. At a time when earnings growth in the US is becoming scarce (despite better-than-expected performances in Q1), a small number of US tech giants keep churning out good numbers. But US equities overall look richly valued and are not factoring in a possible US recession in H2. We therefore remain underweight US equities and continue to favour relatively defensive sectors. We are neutral on European as well as Japanese equities. Sector wise, the boom in AI-related stocks poses fundamental questions for the tech sector at large that still need to be teased out. After surprising positively in Q1, a slowdown in new orders will progressively challenge industrials in the months ahead. As for metals & mining, the downturn in copper prices calls for a certain tactical defensiveness.
Fixed income May saw a big pick-up in UK gilt yields, reflecting stronger-than-expected April inflation figures that fuelled expectations that the Bank of England will continue to hike policy rates. Already well above its US Treasury equivalent, we have raised out year-end forecast for the 10-year UK gilt yield to 4% (from a previous forecast of 3.3%). We have lowered our stance on hard-currency emerging-market (EM) corporate bonds given the decline in their performance relative to developed markets. Our preference continues to go to high-quality investment-grade EM bonds, especially in Asia.
Commodities, currencies, commercial real estate Having recovered faster after covid, copper prices have declined in parallel with oil prices year to date. With the market moving into oversupply, the outlook for copper in the months ahead looks unclear and largely dependent on the Chinese economy regaining momentum. The outlook for oil prices could be brighter given the chance of undersupply in H2. We believe the price of Brent oil could approach USD105 per barrel by year’s end. In currencies, the US dollar has been making a comeback as thoughts of Fed rate cuts have been pushed back and the US economy continues to show signs of resilience. However, this may not last, with a downturn in the US economy in H2 set to reverse the dollar’s recent gains. Listed commercial real estate has been suffering of late. In the US, older offices have been bearing the brunt of the downturn, whereas hotels and logistical facilities have been holding up better. In Europe, indexation of rents to inflation continues to provide some protection, but the risk of equity recapitalisations is generally higher than in the US should property values continue to decline.
Asset-class views and positioning
There are two changes to our asset-class convictions this month. We have moved from an overweight to a neutral position on hard-currency emerging-market (EM) bonds as the rise in yields in developed markets has diminished the relative attractiveness of EM bonds in general. We continue to have an active-management approach to EM corporate bonds, concentrating on the highest-quality part of the universe to find the best risk-adjusted opportunities. We have also pulled back from an overweight position in the euro against the US dollar to a neutral one, believing that the catalysts that drove the euro’s recovery earlier this year have faded. More generally, we remain cautious on equities overall, especially in the US, but see active-management opportunities in select markets and sectors. We likewise continue to believe in an active and selective approach to fixed income that includes an overweight position in long-term US Treasuries and shorted-dated investment-grade corporate bonds in Europe alongside underweight positions in euro peripheral debt and high-yield credits.
Three investment themes
Volatility as an asset class. Treating—and trading—volatility as an asset class in its own right remains an important investment theme for us. We believe recent drops in equity volatility point to signs of complacency. We see various option strategies, including equity hedges and capital-protected notes, as ways to protect portfolios in the event or a renewed pick-up in volatility.
A preference for fixed-rate over floating-rate debt. We prefer fixed-income debt over floating-rate debt, which has become less attractive because of the rise in interest rates since last year. This translates into a preference for countries (and their currencies) where mortgages are largely at fixed rates over ones where variable-rate mortgages are more prevalent.
A time for active management. In equity investing, we believe financial and operational pressure on companies makes a strong case for preferring an approach based on bottom-up stock selection over a passive investment strategy. We believe a similar active approach is warranted when it comes to corporate bonds, where we continue to concentrate on quality.
