We discuss the uncertain outlook facing the global economy and financial markets.
- Investors must navigate a combination of heightened inflation, a more challenged growth outlook and geopolitical tension.
- We have reduced our multi-asset portfolios’ equity exposure in favour of adding to government bond positions.
- Within equities, our focus is firmly on companies with thematic tailwinds.
Investors are asking how high US interest rates will rise and when will they peak, while earnings forecasts are complicated by the uncertain outlook for inflation. This lack of visibility is being exacerbated by several factors.
We have an inflation problem and interest rates are trending higher amid a cost-of-living crisis, putting consumer spending under pressure. This combination would typically lead to an economic slowdown, which markets are to some extent already anticipating.
One reason for the higher inflation we are seeing is geopolitical tension and the war in Ukraine, coupled with the continuing energy transition which is leading to higher commodity and energy prices. There is also potential for divergent economic growth prospects between developed markets and China, with growth in developed markets likely to slow in 2023, but China’s economy having scope to recover if and when Covid-19 restrictions are removed.
Overall, our view is that inflation is likely to remain ‘sticky’ for some time and we do not expect developed-market interest rates to come down quickly.
The earnings outlook
Despite third-quarter earnings reports proving relatively stable, outlook statements were noticeably more cautious. This accords with our view that there is downside risk to earnings numbers into 2023, particularly if recessionary forces prevail.
Overall, our multi-asset strategies are positioned relatively cautiously. We have recalibrated equity weightings towards the bottom of their medium-term ranges and we have started to increase bond weightings. With US Treasuries offering positive real yields, after several years of negative real yields, their relative attractiveness has increased.
As the monetary-policy regime has changed, gold has lost some of its shine. The opportunity cost of holding the precious metal, in an environment in which one can obtain a 4% yield on a US Treasury, has risen. Other alternatives, specifically renewables, infrastructure and music royalties, look interesting and offer potential sources of inflation-protected returns that we believe can also provide diversification in a period of stagflation or recession.
Within equities, our focus is on areas benefiting from long-term thematic tailwinds as identified by our themes, one part of our multidimensional research. One such theme is ‘big government’, which describes the shift from monetary policy to fiscal policy, with the latter increasingly directing capital flows in markets. We seek to take advantage of this via holdings exposed to energy-efficiency initiatives, including green energy. We also have exposure to companies benefiting from wind power and the electrification of power grids.
Another theme, ‘great power competition’, predicts that the liberal democratic and economic order that dominated the last 30 years is now over, as China’s rise, Russia’s revisionism and America’s domestic politics are changing the global balance of power. This theme, which anticipates deglobalisation and increased onshoring and nearshoring, is influencing our thinking. We are looking at companies which should benefit from increased capital spending as new productive capacity is moved out of Asia and into the US and other markets.
Our ‘picture of health’ theme explains that global health-care systems, solutions and delivery methods are entering a new era, characterised by scientific breakthroughs and widening access across both developed and emerging economies. So we see strong long-term demand dynamics providing a tailwind to the health-care sector. In the short term, there have been some challenges such as staff and component shortages in some areas of health care, and adjustments that were made during the Covid-19 pandemic have taken longer to normalise than we, and many health-care companies, expected. Elective procedures, for example, have been slow to bounce back post reopening. There is therefore an element of pent-up demand affecting some areas of health care.
We have recently seen a sharp derating of technology companies, despite earnings having held up relatively well in some cases. We are not unduly concerned because we believe that over the longer term, technology spending will grow as a host of new technologies make networks, systems, processes and products of all kinds increasingly responsive and more intelligent.
Our ‘smart everything’ theme explains how ‘smart’ devices are paving the way for enhanced efficiency and greater productivity. Without doubt, there will be an element of cyclicality over the short term, but we have positioned portfolios around ‘megatrends’ which we believe will perform well over longer periods.
Looking ahead, currency movements may exert less of an influence, as developed-market central banks play catch-up with the US Federal Reserve and interest-rate differentials narrow. Overall, we are relatively cautious because we anticipate that investors will be forced to navigate a challenging combination of heightened inflation, a weaker growth outlook and geopolitical tensions in 2023. However, we firmly believe that the uncertain environment is likely to create opportunities over the longer term, provided investors have the liquidity to take advantage of them.
This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Please note that holdings and positioning are subject to change without notice.