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Many of the themes we covered in May’s update remained broadly intact through June. We also saw key developments, including:
- developed and emerging markets proved more resilient than expected
- Congress resolved the US debt ceiling impasse, at least until 2025
- +0.25% hike from the European Central Bank
- +0.50%hike from the Bank of England, taking interest rates to 5%
Following from the last two points, the Bank of Canada has also recommenced rate hiking and, whilst the Federal Reserve ‘paused’ in June, there are two additional hikes expected for 2023.
We are also seeing signs of the slowdown in corporate earnings growth expectations bottom out and gain positive momentum.
Below we discuss each key component of our investment outlook.
Economic growth.
Economic growth indicators are stronger than expected.
Examples in the US include:
- the Atlanta Fed GDP Nowcast model running at +1.8%.
- unemployment at 3.7% and annual wage growth of +5.6%.
- falling producer prices and real strength in global service sector
The UK has narrowly avoided a technical recession, although Europe has been dragged into one by a slowing German manufacturing sector. We believe the risk of a US recession has been pushed out into 2024.
Economic growth data has been stronger than expected in the UK, however, with monetary policy likely to remain tighter for longer to tackle inflationary challenges, it presents a headwind to growth.
Chinese data continues to disappoint relative to the impulse expected by the market, but nominal and real growth remain strong.
Financial and credit conditions.
We expect credit availability to tighten, a potential substitute for aggressive monetary tightening, to cool inflation.
Examples include:
- the Federal Reserve Senior Loan Officer Opinion Survey, showing 46.7% of US banks have tightened credit terms
- the NFIB Small Businesses Survey indicating 73% of small businesses haven’t borrowed money for business purposes in the last 3 months
- the Fed’s Beige Book noting a tightening of financial conditions in district banks[1]
Inflation.
We anticipate the trend of global headline disinflation to continue, explained by a broader range of factors than simply base effects.
In the US, headline inflation continued to fall providing encouragement that US inflation is moving closer to it’s target level of 2%[2].
We expect core inflation to remain stickier. It is currently running at 5% (3-month annualised basis), driven by upward pressure in shelter costs (33% of the basket) and wages. This theme is not limited to the US, there are similar trends in the UK and Europe[3].
Asset valuations.
There are compelling opportunities in Sovereign Bonds and credit vs equities. However, credit spread valuations are now tight (relative to the last 20 years), hence little appetite from to build exposure significantly at this point.
Within equities, the valuation opportunity is within Japan, Europe, the UK and China.
Market cap weighted US equities look expensive compared to history. This has been exacerbated by the year-to-date rally in a concentrated pocket of seven companies closely linked to the Artificial Intelligence theme. On an equally weighted basis, the US index is trading closer to fair value.
Opportunities for growth.
Given the blend of stronger economic data and pockets of valuation opportunity, we are happy to hold a modest overweight to equities.
However, should a deterioration in economic growth surface, encouraging Central banks to ease interest rates, this would benefit our exposure to global government and inflation linked bonds.
In summary.
- Economic data is proving more resilient
- Recession risks have not been avoided but have been pushed out
- Headline disinflation remains underway
- Core inflation remains a challenge
- Valuations across credit and equity, notably US market cap, have tightened
- Opportunities remain in the Sovereign Bond space, along with Japanese, UK, European, Chinese and US (equal weight) equities
This article is not a personal recommendation or financial advice and the forecasts provided are not a reliable indicator of future performance.
[1] Bloomberg L.P. (June 2023)
[2] Bloomberg L.P. (June 2023)
[3] Bloomberg L.P. (June 2023)
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