Coffee Break

Last week in a nutshell

• Thanks to a positive first half and resilient economic growth, 2023 is unlikely to replicate last year’s disappointing market performances.
• Central bankers gathered at the ECB Forum in Sintra and repeated that more tightening is warranted. The July ECB hike was qualified as a “fait accompli”.
• Headline and core consumer inflation data for the euro zone undershot market expectations, preliminary data for June showed.
• In the US, consumer confidence, housing data and durable goods orders all came out better than expected, justifying the Fed’s hawkish stance.

Investment convictions

Core scenario

• During the second half of 2023, we expect a less supportive market environment than in H1 when financial markets were resilient, reflecting a better growth/inflation mix than expected by consensus at the start of the year.
• The month of June has seen central banks from Australia, Canada, England, Norway to the euro zone and the US add more tightening, via rate hikes and rhetoric.
• The gradual economic slowdown goes on and central banks keep a hawkish tilt even though this monetary tightening cycle is already unprecedented in recent history.
• Our main scenario incorporates sluggish and slow growth, both in the US and the euro zone. The magnitude of the market downside risk will depend on the upcoming economic slowdown. In our central scenario, it should be limited in a tight trading range.
• In the euro zone, the expected next stage of lower economic growth and increasing cyclical worries have likely already started. Deterioration in economic data has been widespread. After peaking in February, economic surprise indicators have fallen sharply into negative territory.
• In Emerging markets, a strong, sustainable momentum behind the re-opening in China has not materialised. Clearly, this is not the post-pandemic recovery the world was betting on. The region, as a whole, should nevertheless see growth accelerating.

Risks

• The steepest monetary tightening of the past four decades has led to significant tightening in financial conditions. Financial stability risks have resurfaced in the US this spring but appeared to have stabilised.
• After the dramatic drop in growth surprises in all major regions outside of the US, the outlook is becoming less supportive.
• Markets appear to have a second thought on the “terminal rate” of several central banks, as their inflation-taming job is likely not finished yet. Consequently, we believe the outlook for growth is tilted to the downside.

Cross asset strategy

1. We have a neutral equities allocation, considering the limited upside potential. A positive economic outcome with a softish landing seems already priced in for equities, thereby capping further upside. We focus on harvesting the carry and are slightly long duration.
2. Within a neutral equities positioning, we have the following convictions:
   • In terms of regions, we believe in Emerging markets, which should benefit from improving economic and monetary cycles vs developed markets.
   • Our positioning on equities is somewhat more defensive and we are underweight euro zone equities as pricing has become too complacent in our view.
   • At this stage of the cycle, we prefer defensive over cyclical names, such as Health Care and Consumer Staples. The former is expected to provide some stability: No negative impact from the war in Ukraine, defensive qualities, low economic dependence, innovation, and attractive valuations. The latter, pricing power.
   • Longer-term, we favour investment themes linked to the energy transition due to a growing interest in Climate and Circular Economy-linked sectors. We keep Technology in our long-term convictions as we expect Automation and Robotisation to continue their recovery from 2022, albeit at a reduced pace.
3. In the fixed income allocation, we have a slightly long duration positioning:
   • We are positive on UK and US government bonds. On this side of the pond, we do not expect the Bank of England to go as far as markets are pricing now; and on the other side, we don’t expect a Fed easing as early as the markets do.
   • We are overweight investment grade credit: A strong conviction since the start of 2023 as carry and duration offer a cushion and we focus on European issuers.
   • We are more prudent on High Yield bonds as tightening credit standards should act as headwind and the buffer for rising defaults has decreased in recent months.
   • We are buyers of Emerging bonds, which continue to offer the most attractive carry. Dovish central banks should become a support. Investor positioning is still light post-2022 outflows. The USD is not expected to strengthen.
4. We have exposure to some commodities, including gold and commodity-related currencies, including the Canadian dollar.
5. Further to the currency strategy, we hold a long position in the Japanese Yen (vs. the US dollar), a good hedge in a potential risk-off environment.
6. On a medium-term horizon, we expect Alternative investments to perform well.

Our Positioning

The overall equity strategy is neutral, with a barbell approach: overweight Emerging markets mitigated by an underweight on euro zone. We are neutral elsewhere. The exposure to the US market comes with a derivative protective strategy as sentiment, positioning, and market psychology are stretched. Markets are increasingly reflecting our soft-landing outlook, limiting the performance potential going forward. Accordingly, our “late cycle” asset allocation strategy is axed around defensive sectors, credit, and long duration.