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.
What a difference a month makes.
It’s been a tough start to 2022 for financial markets, having digested the increased ‘hawkishness’ from all the central banks in the developed world.
Now, interest rates are expected to be higher across all regions – with the exception of China – by the end of the year.
So, what has happened?
A combination of stubborn core inflation rates (they are sitting above target levels), a faster than expected labour-market recovery and unforeseen political pressure have prompted the change in interest rate and monetary policy outlooks. Meanwhile, some of the weakness year-to-date is a hangover from a very strong end to 2021.
In January, world equities delivered -3.4% in euro terms, while fixed income markets generated an aggregate return of -1.1% (in euro).
The big picture
Last month, headline inflation continued to rise, and, in many countries, it is hitting its highest level for many years. This is emerging as a major concern in consumer surveys.
Meanwhile, growth indicators remain robust – and are still pointing to above-trend growth. Of course, the spread of Omicron caused some weakness, but the damage has been relatively limited and appears to be passing in Western economies. Unemployment rates are falling to levels that suggest there is no economic emergency thus allowing central banks to move towards a more normal monetary policy.
We expect some turbulence in China as the country continues its zero-tolerance approach. Looking at the rest of the Pacific Basin, manufacturing is continuing to gather pace, which should help growth and could ease inflationary pressures.
Sticky inflation, monetary policy response increases volatility but it should not derail the recovery
The issue that investors face now is: will inflation impact on future growth, or could the monetary policy response pull growth rates below trend?
This seems unlikely given the level of built-up savings across consumers and the low level of inventory and strained supply systems across corporates.
We do face a significant wind down in fiscal support, but this should be replaced by private sector income.
It is a more difficult environment for fixed income markets: January was a weak month and February is turning out even worse. A surprising pivot by the European Central Bank (ECB) compounded an already worsening background as expectations of interest rate increases get ratcheted up.
It is unlikely that bond markets will show any stability until we get some firm indicators that we are seeing some passing in inflationary pressures.
Bond markets are behaving defensively, while peripheral spreads and corporate spreads in the euro area are widening.
We still favour short-dated exposure, although it has not been performing well recently. Short-dated debt matures relatively quickly, and we can reinvest at higher yields thus providing an improving return as the year progresses. Using short-dated corporate debt gives you this and a higher running yield.
For equity markets, the implications are more balanced: there is the negative impact of rising interest rates and bond yields, but there is the positive of higher nominal economic growth feeding into stronger profit growth. That is what we are seeing in the current reporting period.
Compared to forecasts, US earnings are weaker than the previous three quarters which is to be expected as the cycle matures. Nevertheless, with earnings coming in 5% better than expected – that’s above the long-term average of 3% – it remains a strong earnings season. In Europe, the earnings beat is slightly better at 6%.
And while some companies are struggling to pass on cost pressures (primarily commodity-based pricing and transport costs), overall guidance is rising. It is not as strong as previous quarters, but it is above average – and sales growth is still running at double digit growth rates.
Meanwhile, there’s been a reversal in trends in equity markets since Q4. Energy and Financials are at the top, reflecting strong oil prices and rising bond yields, and structural and defensive growth – such as Healthcare and IT – are at the bottom. We would not expect this to continue. With decelerating growth, we would expect the defensive growth sectors to perform better.
Regional preferences also changed in January, with Asia and emerging markets holding up better than Western markets but we would not expect this to last either as we start to see interest rates rise.
Asset allocation: what’s changed?
We have positioned our portfolios for a change in monetary policy. We hold relatively low fixed-income exposure for the risk profile. But we expect above-trend growth in the global economy, hence our relatively high exposure to equities.
Two major themes are driving our sector strategy. Firstly, reopening, we believe we are at the early stages of this, and there is much profit and share price performance potential in it. As a result, we have relatively high exposure to Consumer Discretionary and Industrials. The other theme is maturing in the economic and profit cycle as growth rates subside, and so, we have relatively high exposure to Healthcare and low exposure to Materials and Energy.
So, what does this mean for our asset-class views?
All things considered, we will not adjust our asset allocation at the moment. It seems too early in the cycle to be moving towards a neutral position in equities.
Growth remains above trend; companies are performing strongly in the current environment; and we have moved to price in quite a lot of central bank action.
We will look to move more exposure towards defensive and structural growth, but this theme will remain out of favour as long as bond yields keep rising.
That said, at some stage, the growth outlook will become a concern, and this theme will come back in favour irrespective of what is going on in the bond market.
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.
Want to learn more?
Every day, we help clients create everything from savings plans; complex pension structuring; directors’ pension planning; inheritance planning; and investment strategies.
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.
Goodbody Stockbrokers UC, trading as Goodbody, is regulated by the Central Bank of Ireland. In the UK, Goodbody is also subject to regulation by the Financial Conduct Authority. Goodbody is a member of Euronext Dublin and the London Stock Exchange. Goodbody is a member of the group of companies headed by AIB Group plc.