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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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I'm an investment expert with a robust understanding of financial markets and economic trends. My experience and knowledge in the field position me as a reliable source for insights on asset allocation, portfolio management, and market dynamics. Let's delve into the key concepts highlighted in the provided article titled "Home Asset Allocation Highlights – Expectations out of Line."
The article touches upon several critical points, and I'll break down the key concepts for a better understanding:
-
Global Downturn and Discrepancy in Views:
- The article starts by noting the global nature of the current economic downturn.
- It highlights the gap between optimistic equity analyst views and the caution expressed by economists.
- Questions the prevailing market belief that central banks won't raise interest rates as much as expected.
-
Inflation and Contributing Factors:
- Argues against the possibility of the end of the rate rising cycle, citing that inflation is unlikely to fade quickly.
- Attributes factors like the Ukraine war, high commodity prices, persistent supply-chain bottlenecks, high house prices, and rising wage demands as contributors to sustained inflation.
-
Earnings Season and Contradictions:
- Acknowledges the positive outcomes of the latest earnings season, excluding specific sectors.
- Expresses skepticism about the sustainability of positive earnings growth, given current economic forecasts that do not align with anticipated economic slowdown.
- Forecasts a potential decline in earnings and suggests that equity prices may follow suit.
-
Portfolio Adjustments:
- Discusses a cautious portfolio positioning, seeking to gradually increase risk in high-grade corporate credit and commodities.
- Four specific changes made to portfolio positioning are outlined:
- Upgrade of credit to 'favour,' particularly in European investment-grade credit.
- Tactical deepening of the short position in European duration.
- Increased tactical exposure to commodities based on fundamental supports and geopolitical factors.
- Sale of modest emerging market exposure while maintaining exposure to Chinese and Japanese markets.
-
Market Outlook and Asset Class Views:
- Highlights the current lack of contraction in global earnings being priced in, contrasting it with the expected drop in earnings.
- Discusses potential scenarios of a 9-17% drop in earnings and its impact on price/earnings ratios.
- Concludes with a note on being underweight duration and neutral on equities.
-
Disclaimer:
- Provides a disclaimer emphasizing that the article is for educational purposes only and not intended as investment advice.
- Warns about the risks involved in investing, especially in emerging markets or specialized sectors.
This breakdown covers the major themes in the article, offering a comprehensive overview of the author's perspectives and recommendations. If you have specific questions or need further clarification on any of these points, feel free to ask.
