Last week in a nutshell
- On the central bank front, the ECB and the Federal Reserve kept a hawkish rhetoric and the former again raised rates by 25bp.
- In China, the PBoC cut interest rates to support its economy, showing the cyclical de-synchronisation compared to the US and Europe.
- Inflation continued to show easing signs as the US CPI hit 4% YoY, and the core-CPI declined to 5.3%.
- Soft data in the euro zone remained sluggish amid concerns over the economic outlook and higher rates, while US initial jobless claims hint towards a softening in the labour market.
What’s next?
- Global flash PMIs will be released helping investors gauge the gap between manufacturing activity and services.
- In the US, Fed Chairman Jerome Powell will provide his semi-annual monetary-policy report to Congress, just a week after the Fed published rather hawkish rate expectations.
- In the UK and Japan, the latest CPI will be published as the Bank of England is meeting and the Bank of Japan is publishing its April meeting minutes.
- On the geopolitical front, US Secretary of State Antony Blinken is coming back from a trip to China to calm US-China tensions, while China’s Premier Li Qang is touring Europe.
Investment convictions
Core scenario
- Financial markets have been resilient during the first semester of the year, reflecting a better growth/inflation mix than expected by consensus at the start of 2023.
- During the second semester, however, we expect a less supportive market environment as 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 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, Chinese pent-up demand was a positive point but a strong sustainable momentum behind the re-opening has not materialised yet. Clearly, this is not the post-pandemic recovery the world was betting on.
Risks
- The steepest monetary tightening of the past four decades has led to significant tightening in financial conditions. Financial stability risks have resurfaced recently in the US but appeared to have stabilised.
- After the dramatic drop in growth surprises in all major regions, the outlook is becoming less supportive.
- Markets appear to have a second thought on the Fed’s job, which likely is not finished yet.
- In Europe too, the ECB is hawkishly tilted and geopolitical tensions are not supportive. We believe growth is at risk.
Cross asset strategy
- We have a neutral equities allocation, considering the limited upside potential. The positive economic scenario seems already priced in for equities, thereby capping further upside. We focus on harvesting the carry and are slightly long duration.
- 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 recently became somewhat more defensive and we reduced exposure on 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.
- In the fixed income allocation, we have a slightly long duration positioning:
- We are positive on US government bonds as the slowdown is advancing in the region. We do not expect a Fed easing as early as the markets do. We are neutral euro zone duration.
- 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 strong tightening credit standard 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 be supportive. Investor positioning is still light post-2022 outflows. The USD is not expected to strengthen.
- We have exposure to some commodities, including gold and commodity-related currencies, including the Canadian dollar.
- Further to the currency strategy, we added a long position in the Japanese Yen (vs. the US dollar), a good hedge in a potential risk-off environment.
- On a medium-term horizon, we expect Alternative investments to perform well.
Our Positioning
The overall equity strategy is neutral, with a preference for Emerging markets, and an underweight euro zone equity. We are neutral elsewhere. The exposure to the US market comes with a derivative protective strategy as sentiment, positioning, and market psychology are getting stretched. Markets are increasingly reflecting an improved outlook, limiting the performance potential going forward. Our “late cycle” asset allocation strategy is axed around defensive sectors, credit, and long duration.
