House View

Inview February 2024

Editorial

Welcome to the February edition of Inview: Monthly Global House View. In this publication we consider significant developments in the world’s markets, and discuss our key convictions and themes for the coming months.

2024 has started positively for global markets, continuing the trend seen in the fourth quarter of 2023. The MSCI World equity index rose by 1.1% in January, approaching the all-time high set in early 2022. The 10-year Treasury yield ended January up by about ten basis points, having gyrated around 4% for much of the month. With regard to currencies, the US dollar trade weighted exchange rate index rose by almost 2%, supported by the strong performance of the US economy.

However, this favourable picture is not without risks. The Chinese economy and equity markets remain weak – as evidenced by the liquidation of Evergrande – and the Chinese authorities appear reluctant to implement meaningful stimulus measures. That said, Chinese stock prices are already pricing in a very negative scenario and it may take only a marginal shift in the news flow to improve sentiment.

The rise in stock markets, especially in the USA, remains very concentrated. Seven big US technology companies continue to dominate the market. The risk is that, following such a strong rally, they correct and that this negatively impacts broader index performance. Furthermore, new concerns about US regional banks weighed on the performance of small and medium-sized companies.

Markets also have to deal with ongoing tensions in the Middle East. The risk of an escalation of the conflict cannot be ruled out and if this were to happen the repercussions on international trade, global growth and inflation would likely be negative.

Finally, central banks have frustrated market expectations of an imminent easing of monetary policy, with an emphasis on “data dependency” and wanting to see a more “sustainable” decline in inflation before cutting rates. Maintaining restrictive financial conditions will act as a headwind to economic activity and corporate earnings growth.

In the short term, there remains a favourable backdrop for risky assets. Therefore, in our view an overweight exposure to equities is recommended, with a preference for US and European markets. The decline in Chinese equities has encouraged us to increase exposure to neutral and, conversely, we have reduced exposure to Japan to neutral following a strong rally last year and so far this year. Within fixed income, the preference is for government and investment grade bonds which offer an attractive mix of risk and return.

Asset Allocation

Global Allocation

Fixed income and equity markets have been giving confusing messages. We expect that either there will be a re-pricing in the bond market as there is a greater degree of confidence that the economy will avoid a hard landing and not so many rate cuts will be needed, or we will observe an increase in volatility and a sell-off in equities if conditions deteriorate that warrant a series of rate cuts. While recession risks have increased, we do not expect this to materialise until there is greater complacency in markets.

No changes were made to the broad asset allocation. Given the drift in markets, we slightly rebalanced to maintain our overweight in equities while increasing fixed income marginally to keep the weighting neutral. We are watching closely for any signs that the recent equity rally is coming to an end and that will encourage us to reduce our equity allocation back to neutral at some point this year. However, general conditions do not suggest that we have reached that point and valuations don’t look sufficiently expensive to warrant this yet.

Asset Allocation
Fixed Income

We are not making any changes to our fixed income sub-sector allocation this month. This sees us maintain a preference for sovereign bonds, favouring around 6.5 years of duration. We also hold our positive view on investment grade bonds, given that spreads have remained tight. While we expect that the Federal Reserve will wait until May to make its first rate cut, March’s meeting will likely be in focus and so it may be necessary to make some changes ahead of then. We remain cautious on high yield credit despite the good performance of the asset class in 2023.

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Equities

The EFGAM Combined Valuation model continues to show Asian equities are particularly cheap, which is associated primarily with Chinese valuations. As such we are increasing our allocation to Asia ex-Japan, taking it up to neutral. Within this region the most significant change was an increase in our Taiwan allocation, moving up to neutral, while rebalancing exposure to smaller economies. At some point we anticipate a powerful policy response from Chinese authorities which will trigger a market rally. However, it is hard to anticipate the magnitude and timing of this and so we see it as too early to go overweight. To fund the increase we are taking profits from Japan, where valuations now look expensive for a number of sectors, moving to an underweight position. We note that while we have not adjusted our US equity positioning, given that the neutral allocation of the benchmark has marginally increased, we are technically now moderately underweight relative to it.

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Alternatives

Within alternatives we are upgrading insurance linked securities to overweight, as we view yields as attractive and the asset class’s low correlation adds diversification benefits. To fund this, we are reducing our allocation to hedge funds, moving back to a neutral position versus the benchmark level. In addition, our underweight to commodities was further reduced. This is due to our commodity focus being on gold and the weaker prospect for economic activity makes it appropriate to reduce allocation.

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