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Portfolio perspectives | Article - 2 Min
2 Authors - Portfolio perspectives
08-02-2022 · 2 Min
Given that the current downturn really is global, we are struck by the gap between optimistic equity analyst views and the caution voiced by economists. We also do not follow the market’s belief that central banks will not raise interest rates by as much as had been thought given the poor economic news. Can the end of their rate rising cycle already be in sight?
Not for us. Inflation is unlikely to fade quickly enough. The Ukraine war will likely keep (commodity) prices high; supply-chain bottlenecks will not be easing anytime soon. High house prices will likely keep pressure on rents for months to come. Wage demands are rising in response to a tight labour market and high inflation.
We expect it to take more central bank tightening, and a bigger slowdown in growth, before inflation falls to anywhere near policymakers’ targets. Consequently, we are underweight duration.
Earnings season
In this context, the latest earnings season has nonetheless been encouraging. Excluding a strong showing by the energy sector and large declines for financials, both sales and earnings growth have been positive (and above expectations). We do not think this can last. Current forecasts (see Exhibit 1) do not gel with the economic slowdown we anticipate. Earnings will likely fall and equity prices should follow suit.
The lack of any contraction in global earnings being priced in now contrasts starkly with the 9-17% drop in earnings that is likely when they return either partly or fully to trend. A 9% fall places the price/earnings ratio at 16.3x for the MSCI US – roughly where it is today. A larger 17% fall is consistent with a P/E of around 19.5x, while a meaningful recession could see a 35% drop in earnings.
Portfolio adjustments
Our multi-asset portfolios are cautiously positioned: we are seeking to increase risk gradually in areas such as high-grade corporate credit and commodities, while we are underweight duration and neutral on equities.
We made four changes to portfolio positioning during the month:
- First, we upgraded credit to ‘favour’, looking in particular at European investment-grade credit where distress is now pronounced and where the valuation opportunity looks increasingly attractive. European IG appears to be pricing in an 8-10% implied default rate – that is twice the worst rate over the last five years and eight times the historical average. That looks too gloomy given the shallow 2001-style correction we expect and the broadly healthy corporate finances.
- Second, in European duration, we tactically deepened our short. Responses to the gas crisis are likely to be fiscally-led given central bank concerns around inflation in the near term and the propensity for tighter policies.
- Third, we deepened our tactical exposure to commodities. Fundamental supports include resource nationalism and greenflation, but also geopolitics – commodities typically benefit in uncertain times. There is also a clear scarcity of supply. Finally, there is support from Chinese macroeconomic policy which continues to lean towards easing.
- Fourthly, we sold our modest emerging market exposure, while keeping our Chinese and Japanese exposures against a broadly offsetting European short.
Asset class views
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Disclaimer
Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
- Central banks
- Inflation
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As an investment expert with a comprehensive understanding of portfolio management and financial markets, I can provide insights into the concepts mentioned in the article "Home Asset allocation highlights – Expectations out of line Portfolio perspectives." Let's break down the key points mentioned in the article and delve into each concept:
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Divergence between Equity Analysts and Economists: The article discusses the discrepancy between the optimism expressed by equity analysts and the cautious sentiments voiced by economists amidst a global downturn. This indicates a nuanced understanding of market dynamics and the importance of considering various perspectives when making investment decisions.
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Impact of Central Bank Policies on Interest Rates: The authors challenge the market's belief that central banks will not raise interest rates as much as previously anticipated due to poor economic news. They argue that inflationary pressures, exacerbated by factors like the Ukraine war and supply-chain disruptions, are unlikely to dissipate rapidly. This demonstrates a keen awareness of macroeconomic factors influencing monetary policy and interest rate decisions.
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Expectations for Earnings and Equity Prices: The article suggests that current forecasts for earnings growth do not align with the anticipated economic slowdown. It anticipates a decline in earnings and subsequent pressure on equity prices. This reflects a deep understanding of earnings trends and their impact on market valuations.
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Portfolio Adjustments: The authors outline specific adjustments made to their multi-asset portfolios in response to the prevailing market conditions. These adjustments include increasing exposure to high-grade corporate credit and commodities while being cautious on duration and neutral on equities. This highlights a proactive approach to portfolio management and asset allocation.
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Asset Class Views: The article provides insights into the authors' views on different asset classes, such as European investment-grade credit, duration, and commodities. Their rationale for each asset class reflects a nuanced understanding of market dynamics, risk factors, and valuation metrics.
Overall, the article demonstrates a sophisticated understanding of financial markets, macroeconomic trends, and portfolio management principles. It showcases the authors' expertise in analyzing market data, formulating investment strategies, and making informed decisions to navigate changing market conditions effectively.
