Portfolio Perspectives, May 2024

Maintaining caution on equities 

There has been little movement in world equities since our last edition of Portfolio Perspectives. There was an interest rate-related wobble in April but that has reversed as we travelled through the early part of May, and we are now almost back to where we were at the end of the first quarter. 

The inflation reports were disappointing during the last month. In the euro area, we had the first reading of core CPI faster than expected this year. On the bright side, it is still falling on a year-on-year basis but there is a fear that the stickiness in the US will travel across to the euro area. In the US, the PCE disappointed, it was the one measure of inflation in the US that was performing well but it too now has started stalling on a year-on-year basis.

Growth statistics evened out across the globe. In the euro area, the service sector of the economy is reviving, while in China it is the export side of the economy that is showing the best momentum. In the US data releases are, at best, matching forecasts. The consumer in the euro area and China remain the real challenges for these regions.

Defensive sectors took the lead as interest rate volatility arrived and growth statistics weakened relative to expectations. However, on a year-to-date basis equity markets have been cyclically led as the global economy is registering stronger growth. The results season is giving a boost to the new economy sectors as the demand growth trends remain in-tact.

The results season has been strong in the US with earnings up 4% year-on-year which is nine points higher than forecast. Guidance is also much stronger, almost 40% of companies that have reported have increased guidance against 10% that have cut guidance. In the euro area, earnings are still declining and were not much different to forecast.

The economic background has turned out better than expected. Earnings news does give confidence around current year forecasts. Interest rate expectations are more realistic now. However, equity prices have moved to reflect this improvement so one should maintain an element of caution.

Bernard Swords,
Chief Investment Officer

Increasing our allocation to actively managed corporate bond funds 

This month’s Asset Allocation Committee meeting focused on the performance of markets year to date, turns in trends in April and the addition of a new corporate bond manager into the model portfolios. Whilst there was no change to strategy on an overall level, there were some slight changes across the mix of investments within the fixed income portfolios.

As discussed in this week’s Investment Viewpoint, fixed income markets are down for the year. However, the themes that have been driving markets year to date appear to be losing a little bit of steam, as evidenced by the positive month-to-date performance of fixed income markets. It seems a combination of weaker labour market data in the US followed by constructive central bank commentary has reduced the pressure on any further pricing out of cuts, giving relief to fixed income markets, and leading to a slight reversal of trends.

In terms of market drivers and performance, European investors who have had a slightly lower duration exposure, and overweight allocations to corporate bonds, would have done well year to date, as US and longer duration government bonds have been the main laggards. This dovetails well with the current fixed income strategy. Going forward, there may be an opportunity to extend duration albeit positioning for now remains unchanged.

Where there were some slight changes in strategy was in the corporate bond investment portfolio. The committee approved a move away from passive corporate bond investments, increasing allocations towards actively managed corporate bond funds. Passive funds offer investors the opportunity to gain exposure to a broad market index, whereas active managers aim to generate performance which outperform the index. To do so, managers require taking active risk exposures to generate active returns. The backdrop of future rate cuts and weak but not negative economic growth presents an opportunity for active managers to take advantage of market volatility and diverging trends. 

Elizabeth Geoghegan,
Head of Fixed Income Strategy

Rebalancing our flagship equity portfolio 

In addition to the changes outlined above to our fixed income portfolios, within equity, we are rebalancing our flagship portfolio, increasing exposure to sectors where projected earnings growth is stronger and there is less risk around forecasts being achieved, and reducing relative defensiveness. We are moving from an overweight to a neutral position in Consumer Staples, and increasing Technology from an underweight position to neutral, with a particular focus on increasing exposure to mega cap stocks.

Technology earnings momentum remains high, and we have seen the initial AI enthusiasm transform into physical demand. In flagship models where Technology positioning is light, we are increasing our exposure to US Technology to align exposure with the benchmark.

To finance this, we are reducing our exposure to Consumer Staples which has been a defensive overweight in our flagship portfolios. Earnings momentum is poor in the sector as consumers push back against the price increases they have had to face over the last couple of years. Of the major sectors, it has seen the largest downgrades over the last three months. Valuation is low but this is confined to the Food, Drink and Tobacco segment which face the challenges of increasing health awareness amongst consumers and the rise of the ‘obesity theme’. Consequently, we cannot see much scope for a revaluation of the sector and have decided to reduce exposure here.

Price moves have increased our exposure to Industrial Services and we have decided to take some profit here. We still like the segment but it had become too large in portfolios. We are using the proceeds to increase our exposure to the ‘decarbonisation theme’. A lot of the hype has come out of the theme, so entry levels are now attractive again.

Similarly, price moves had pushed up our weighting to the Construction Industry. This was driven by strong earnings growth but had become too large in our portfolios. Additional alignment switches include increasing exposure to Energy and Healthcare (MedTech) where positioning is below the desirable target and reducing overweight Consumer Discretionary positions to neutral.

Sarah Hanly,
Investment Associate, Investment Solutions