Coffee Break

Last week in a nutshell

• Interest rates and geopolitical uncertainties are the most significant market drivers. Among several central bank interest rate hikes announced last week, the US Federal Reserve Bank hike of 75bp and its forward guidance of additional +125bp by year-end reminded investors that “some pain” lies ahead.
• Bucking the trend of other central banks, the Bank of Japan has remained ultra-loose. The JPY has lost about a fifth of its value against the USD, prompting the Japanese government to intervene. The last time Japan strengthened the yen with direct intervention was during the Asian financial crisis in 1998.
• September Flash PMI in the euro zone and the US showed a weakening trend on this side of the Atlantic and an uptick on the other side of the pond. In Europe, consumer demand is falling amid rising cost of living and growing gloom about prospects and output capabilities are constricted by soaring energy prices.
• Drawing condemnation from China, India, Turkey and the West, Russia started an annexation vote in occupied areas of Ukraine. President Putin’s order of partial mobilisation further raised the stakes in the seven-month-old war.

Investment convictions

Core scenario

• The risks we previously outlined are starting to materialize and are now part of the scenario.
• As a result, our asset allocation has become slightly more prudent as central banks are committing for even higher rates for longer, leading us to reduce the portfolio duration to a slightly short positioning.
• The Fed continues its hiking cycle along with a quantitative tightening, i.e., a balance sheet reduction. In our best-case scenario, the Fed succeeds in a soft landing of the economy while avoiding a full-blown recession.
• Inflation is at highs in the euro zone, hitting businesses, consumers, and ECB policymakers alike. The ECB has made it clear that the only path forward is higher rates. If growth holds up, 10-year interest should go above 2%.
• Our equity allocation reflects the conviction that European equities are set to underperform in an environment of high inflation, a hawkish ECB and a sharp slowdown in economic growth. As a result, we expect more substantial earnings downgrades in the region than elsewhere. Given the unfavourable risk/reward, we have a negative stance on euro zone equities.
• While the outlook for global equities deteriorates as revenues, margins and, ultimately, profits could be revised down, we expect emerging market equities in Asia to outperform as valuation has become attractive while the region keeps superior growth prospects vs. developed markets.

Risks

• Upside risks include weak sentiment and positioning. Further, governments in Europe are adding fiscal aid as the energy crisis deepens, which could mitigate its negative impact.
• Downside risks would be a monetary policy error via over-tightening in the US or a sharp recession risk via a deeper energy crisis in Europe.
• The war in Ukraine is ongoing but signs of discomfort with Moscow are growing in the international community.
• The threat of COVID-19, and its variants, remain as the virus keeps evolving and spreading at various speed throughout the world.

Recent actions in the asset allocation strategy

We have tactically reduced our portfolio duration and are now slightly short duration as growth has so far shown resilience while inflation continues to surprise on the upside, leading central banks to tighten even more. Strategically, we have gradually increased our fixed income exposure duration along with central bank monetary tightening since the spring as bond yields are now in positive territory. We remain overall neutral equities but underweight euro zone because of the unfavourable risk/reward ratio. We keep using derivatives. We remain neutral elsewhere. We are adding JPY vs. USD as we identify various drivers for the JPY to strength. We have taken some profit on our long commodity currency exposure but keep a slight overweight which is expressed in the portfolio via the CAD.

Cross asset strategy

1. Our multi-asset strategy stays more tactical than usual and can be adapted quickly:
   
   • Underweight euro zone equities, with a derivative strategy in place.
   • Neutral UK equities, resilient segments, and global exposure.
   • Neutral US equities, with an actively managed derivative strategy.
   • Neutral Emerging markets, but positive on Asian Emerging markets, expected to outperform as valuation has become attractive while the region keeps superior growth prospects vs. developed markets.
   • Neutral Japanese equities, as accommodative central bank, and cyclical sector exposure act as opposite forces for investor attractiveness.
   • Positive on sectors, such as healthcare, consumer staples and the less cyclical segments of the technology sector.
   • Positive on some commodities, including gold.
   • In the fixed income universe, we have tactically reduced our portfolio duration and are now slightly short duration.
   • We continue to diversify and source the carry via emerging debt.
2. In our long-term thematics and trends allocation: While keeping a wide spectrum of long-term convictions, we will favour Climate Action (linked to the energy shift) and keep Health Care, Tech and Innovation.
3. In our currency strategy, we have taken some profit on commodity currencies:
   • We are long CAD.
   • We are long JPY.

Our Positioning

We have tactically reduced our portfolio duration and are now slightly short duration as growth has so far shown resilience while inflation continues to surprise on the upside, leading central banks to tighten even more. Strategically, we have gradually increased our fixed income exposure duration along with central bank monetary tightening since the spring as bond yields are now in positive territory. We remain overall neutral equities but underweight euro zone because of the unfavourable risk/reward ratio. We keep using derivatives. We remain neutral elsewhere. We are adding JPY vs. USD as we identify various drivers for the JPY to strength. We have taken some profit on our long commodity currency exposure but keep a slight overweight which is expressed in the portfolio via the CAD.