Every month, our Asset Allocation Committee meets to discuss and debate our market outlook.
How has our asset allocation changed month-on-month?
Here Bernard Swords, Chief Investment Officer, presents our views.
A bit of cheer around financial markets since the last Top Down. World equities are up 2.8% in Euro terms and there has been a nice recovery in the bond markets with the euro area aggregate returning 3.2%. Equity market returns were held back by a weakening in the US Dollar, the trade weighted exchange rate fell nearly 6% over the period although it is still up over 11% year-to-date. For the bond markets, some better news on inflation was the primary positive factor. Stronger bond markets helped equity markets and there was also some relief from the third quarter reporting season.
Easing in fears
Inflation fears subsided somewhat over the last month due to a softer than expected CPI report from the US. For the first time in some time, inflation came in lower than expected at both core and headline level. Particularly pleasing was a 0.4% fall in core goods prices month-on-month and a significant drop in healthcare inflation. It is only one figure and we need to see this become a trend before saying we have passed the maximum pricing pressure.
Growth outlook still weak
Growth indicators were reasonable during the month. Retail sales and industrial production surprised on the upside in the euro area and there was even broader strength in the US. But the consensus forecast growth rates are still declining with the focus now on 2023. Forecasts for 2022 in both the euro area and the US were nudged up slightly as the incoming data has been more resilient than expected. However, it does appear at this stage that if a global recession is avoided in 2023 it is likely to be by a small margin. The one part of the globe that has been struggling over the last month is China. Its zero-tolerance approach to the Covid virus is yielding a stop-go pattern to economic activity and this does not seem likely to change.
The minutes from central bank meetings showed some slight change. In the ECB meeting there was some discussion of the impact of the monetary tightening on the growth rate of the economy for the first time. It will continue to hike but we have the first signs it may be more responsive to activity levels. In the US the Federal Reserve has not changed its line of thinking. The ‘dot plot’ will be moving up but looks like it will lie below current market projections so there has been no new ‘bad news’.
UK back to normal?
The saga of fiscal policy in the UK is coming to an end. After a brief flurry with fiscal reflation the UK is now set on a course of fiscal rectitude. As a result, gilts yields and the Sterling exchange rate are now back to where they were prior to the ill-fated mini-budget of the Truss administration. While one could say everything is back to normal now the UK has been left committed to a tighter fiscal stance over the next several years than was the case before the whole episode began.
Better sentiment in markets
The recovery in bond markets was more about improved sentiment rather than any great change in expectations. In the euro area interest rates are forecast to peak at 3% and in the US at 5%, the same as a month ago. It is a good outcome that those forecasts have not increased, as for the past number of months we had a steady increase in them, so stability has been a relief.
We have been increasing our fixed income exposure and we are not yet up to our target levels. The bond market has rebounded recently and hence we are holding our current position. There is a large gap again between 10-year yields in the euro area and US and where interest rates are expected to peak. We would like a more reasonable gap between them before increasing our exposure any further.
Equity markets have had a good run since the last Top Down, up over 7% in local currency terms. However, improved sentiment across financial markets led to a movement out of the ‘safe haven’ US Dollar bringing the euro return from world equities down to 2.8%. Better bond markets were a positive and the third quarter results season provided some relief. In the US, earnings were 3% above forecast but excluding the Energy sector this dropped to 1%. In the euro area the beat was 5% but ex-Energy this drops to 2%. This is below average but not a major surprise given the macro backdrop. There have been cuts to forecast earnings growth for 2022 (-1.2%) and 2023 (-1.8%). Earnings forecasts are coming down but are not expecting recessionary conditions overall. Valuation does lie below long-term averages so it has built in some downside to earnings but it can go lower.
There was a cyclical bias to sector performance over the last month and most of this can be put down to an increase in risk appetite. The best performing sectors were Materials, Industrials and Financials but these had been some of the weaker sectors in the previous month. Consequently, we would see these as relief rallies rather than any change in trend. We still believe that relative earnings growth will drive sector performances and that profit resilience of the defensive sectors will lead to outperformance in 2023.
Asset allocation: no change
No change to assets, keep cash at 0%
We are maintaining our current positioning. Markets remain focussed on the inflation outlook and there is a good chance that we are starting a period of better inflation data which would boost both bonds and equities. The outlook for the global economy has deteriorated over the last month. The recent trend has been for these forecasts to be cut and thus the risk is to the downside for them. This means we should get softer data, in particular from the US, and this should ease inflation fears, pushing bonds and equities higher still by the year end.
Chief Investment Officer
Bernard joined Goodbody in 2002 and is Chief Investment Officer. As CIO, he formulates and implements the global investment strategy and chairs the asset allocation committee. Bernard also leads the investment research team.
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Warning: This does not constitute investment advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any person. You should not act on it in any way and are advised to obtain professional advice suitable to your own individual circumstances. The value of your investment may go down as well as up. You may lose some or all of the money you invest. Past performance should not be taken as an indication or guarantee of future performance; neither should simulated performance. The value of securities may be subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities.
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