Top Down
Stronger Growth Data Helps to Dampen Recession Fears
Every month, our Asset Allocation Committee meets to discuss and debate our market outlook.
How has our asset allocation changed month-on-month?
Chief Investment Officer, Bernard Swords, presents our views.
Since the last Top Down, there have been small movements in financial markets. Equity markets continued their recovery and world equities delivered 1.4% in euro terms. However fixed income markets stalled with the euro area aggregate down 0.7%. Themes that investors remain focused on are: a ‘soft landing’ in the US, a more resilient performance from the European economy and China’s re-opening. Equity markets are focussed on the growth implications of these developments while the fixed income markets dwell on what they mean for future interest rates.
European Central Bank remains aggressive
There is some divergence emerging between central banks in the developed world. The European Central Bank remains determined to fight inflation. It increased rates by 50 basis points (bps) at the recent meeting and indicated another 50bps for March. After that it will become data dependent and we have yet to see a conclusive easing in the inflation data. In the US, Chair Powell took a softer line, reversing from his previous position of worrying about ‘unintentional’ easing in financial conditions. The minutes from the FOMC meeting also talked about disinflation in the system. Chair Powell made it clear however, that policy will remain restrictive until inflation is back towards target, meaning interest rates will be higher for longer.
Inflation was for once in-line with expectations at both headline and core level in both the euro area and the US. The journey remains better in the US with headline dropping faster than expected, which is good news for the consumer. Core US inflation is less than forecast which is better for the central bank. In the euro area, headline is decelerating more rapidly than expected, which will help consumption, but the core level remains very sticky which will keep pressure on the ECB.
Better economic growth data
The growth background has improved since January and there have been increases to global forecasts for 2023 with a better outlook for the euro area and China. The euro area has proven more resilient than expected with less fallout from the energy crisis than feared. Recent data from the US has also been better, especially employment growth. The probability of a global recession has declined but not gone away. We face the impact of last year’s monetary tightening as we travel through 2023 so that even if recession is avoided, growth will still be below trend.
Fixed Income pausing
The sharp recovery in bond markets has stalled since the last Top Down. After the significant move down in yields at the start of the year, some consolidation was to be expected. The better data from the US and the strong language from the ECB has also caused the markets to pause. There has not been any great change to forecasts for peak interest rates but the ‘higher for longer’ message has made an impact, so less cuts in interest rates are expected in 2024.
Equities still rising but the pace has decelerated
The better economic growth data that has emerged since the start of the year pushed equity markets modestly higher but rising bond yields are curbing enthusiasm. We are almost finished fourth quarter reporting which has not produced any shocks but it is one of the weakest relative to expectations since the Covid-19 recession. In the US, earnings are down 2% year-on-year and are only 1% better than forecast, which is the smallest level of surprise we have had since 2019. In Europe profits are down 2% year-on-year, 2% higher than forecast. We expect 2023 to be a tough year for profits, the forecast growth rate has been cut to 1% and we expect it to be cut further.
Remaining cautious, no change to Asset Allocation
Economic news has been stronger over the month and the chances of a global recession has receded, but not disappeared. If avoided, the global growth rate will still be relatively anaemic. We have a cautious view of equity markets as we are not certain of where economic momentum will trough and how profitable companies can be under current conditions. Cyclical sectors are performing well. We also maintain a defensive bias within equities. In the US reporting season, the sectors which performed best against expectations were Consumer Discretionary, Healthcare and Utilities. Two of the top three sectors were defensive. With a tougher profit environment in 2023, this trend should become stronger.
Asset allocation: Remaining cautious
Close to the peak in interest rates
Inflation does appear to have peaked and there are enough signs that it will subside. Consequently, we believe we are very close to the peak in interest rates and thus our more constructive view of the fixed income markets. However, we think that expectations about the timing of monetary policy easing could be ambitious given the level of core inflation in developed economies relative to target levels. Hence, we would maintain a short duration bias, the long end of bond markets appear to be pricing in quicker interest rate cuts than we feel justified at the moment.
Bernard Swords,
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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