Portfolio Perspectives, April 2024

A broadening out of economic performance 

March was another good month for equity markets with the world index delivering a total return of nearly 4% in euro terms. Resilient economic performance with the prospect of interest rate cuts in the second half of the year were the main drivers during the month. The better economic performance broadened out, geographically, in March with better data coming from the euro area and China.

There were upgrades to 2024 global economic growth forecasts largely driven by a better outlook for the US economy. The strength in the US is still coming from the consumer but the last reading form the Manufacturing ISM (the main business survey) was just above 50 indicating that the manufacturing sector in the US maybe back in growth mode. In the euro area and in China, there was improvement in the main business sentiment surveys (the PMIs) but the consumer in both these regions remains relatively subdued. The most we can say about the euro area and China is that the deterioration has stopped rather than any major turn in momentum.

This broadening out in economic performance fed through to regional performance in equity markets. The US market, which had been the strongest market, underperformed in March with the euro area taking the lead. This also happened at the sector level. In March, the cyclical sectors (Industrials, Financials and Energy) led while IT and the defensive sectors underperformed. The cyclical sectors were probably due some catch-up, but we would be nervous about chasing them – the data is not that strong.

Earnings forecasts remained relatively stable during the month. This is probably a good sign. We are at the start of the first quarter results season, and we normally see some downward adjusting of profit forecasts going into a results season. We have not seen that on this occasion which is encouraging.

quity markets have been strong this year driven by a better economic out-turn and what that means for earnings growth. They have ignored the deterioration in interest rate expectations in the belief the higher economic growth will offset any negative impact from this. It could turn out to be correct but for the moment we would err on the side of caution.  

Bernard Swords,
Chief Investment Officer

A focus on European fixed income markets 

This month’s Asset Allocation focused mostly on the performance of markets and portfolios in the first quarter of the year. As discussed in a recent edition of Investment Viewpoint, it was a tough quarter for fixed income with US and European aggregate indices falling 0.33% and 0.78%, respectively. The performance underneath was a little more mixed as corporates continued to post yet another quarter of positive gains whilst government bonds retreated following a stellar quarter in Q4 of last year.

For investors who may not have added long duration bonds ahead of the stellar performance in the final quarter of last year, there were ample opportunities this quarter to add duration at attractive levels, as government bond yields continued to unwind higher, sparked by the repricing of what was overly optimistic rate cute expectations at the end of last year. The reversal of rate cut expectations was most significant in the US whereby rate cut expectations moved from expecting six to seven cuts by the end of 2024 to pricing about three cuts at the end of the quarter, and  less than two cuts today, as at the time of writing. Unsurprisingly of course, this led to weaker performance in the US relative to Europe or UK fixed income markets.

From a strategy perspective there were no changes to strategy this month. The strategy continues to hold a constructive view for long duration assets (albeit remaining mindful of US repricing), a positive overweight to European corporate bonds and maintains a primary focus on European fixed income markets.

The focus on European fixed income markets is a particularly poignant strategy view today. Last year we rotated out of US assets focusing more on European assets, predominantly due to a better yield landscape in Europe relative to history. However today the weaker European growth outlook relative to the US poses as a fundamental anchor for European long duration assets, something which has helped to keep European government bond yields a lot more anchored relative to their US counterparts.

The focus on overweight corporate bond allocations remains a continued focus within portfolios. Despite Europe having a weaker economic outlook relative to the US, the probability of recession for both regions has faded. This benefits corporate bonds as the risk of a pick-up in the default cycle is therefore lowered, which helps corporate bond spreads to remain well behaved. Relative to the US, European corporate bond spreads also appear a lot more attractive on a valuation basis as the spreads remain slightly elevated due to overhangs such as the Russian Ukrainian invasion. This higher spread enhances the yield pickup from European corporates which overtime compounds helping to enhance future expected returns.

Elizabeth Geoghegan,
Head of Fixed Income Strategy

Reflecting on adjustments to portfolio positioning in Q1 

In the past month we have made no further changes to our flagship portfolios. However, over the course of the first quarter we have made several adjustments to portfolio positioning.

The mix of fixed income in our flagship portfolios changed as we used the weakness in the fixed income markets to increase the duration further  within the sovereign debt allocations. These changes achieved a neutral position  from a strategy perspective. Relative to the benchmark we remain overweight corporate bonds and moderately underweight duration .

We also made strategic changes within flagship equity allocation. In Healthcare we increased the exposure to the Med Tech segment and reduced the exposure to Pharmaceuticals. Med Tech has underperformed over the last couple of years due to a high rating and the overhang from the Covid disruptions. We believe that is now passed and the valuation is now below its long run average. In addition, it is election year in the US which can be a troubled time for the pharmaceutical sector. We also switched amongst the cyclical sectors. We reduced financials (selling Capital One which had performed strongly) and increased industrials (purchase of Ashtead which has lagged the sector performance and should be able to recoup that).

The two largest overweight sector positions in equity remain Healthcare and Industrials and we have constructed our equity portfolios for a mature stage in the cycle. This means more structural growth and less exposure to cycle growth. We would look to maintain that positioning.

Overall, positive market movements have meant that our equity allocation across models has increased. Even so, conditions have also become more equity friendly. As such we are happy to maintain the current allocation to higher risk assets.

Sarah Quirke,
Head of Investment Solutions