Asset Allocation Update: Stability Maintained Despite Market Volatility

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June was a brutal month for the markets. Fortunately, July came to the rescue. The S&P500 rebounded 9.1% (the third best July on record). The stock market indices of the rest of the world were not left out (Chart 2). Bonds were also purchased; US 10-year yields fell 31.0 basis points, while they fell further in Germany and the UK. Meanwhile, commodities recovered 4.0% and the crypto is off its losing streak, at least for now.

What caused this? During the month of June, emerging market central banks ratcheted up the pressure – aggressively raising interest rates – and markets thought we were headed for a recession. This hurt the assets. However, in July, the markets decided enough was enough. They thought the Fed had done the lion’s share of the job on inflation; they were calling for a peak in price rises and interest rate cuts in 2023. We disagree, but risk assets nonetheless rallied. Central bank prices were not the only driver, however: the pessimism surrounding China seemed to have bottomed out; Russian gas has started up again; and revenues could have been much worse.

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June was a brutal month for the markets. Fortunately, July came to the rescue. The S&P500 rebounded 9.1% (the third best July on record). The stock market indices of the rest of the world were not left out (Chart 2). Bonds were also purchased; US 10-year yields fell 31.0 basis points, while they fell further in Germany and the UK. Meanwhile, commodities recovered 4.0% and the crypto is off its losing streak, at least for now.

What caused this? During the month of June, emerging market central banks ratcheted up the pressure – aggressively raising interest rates – and markets thought we were headed for a recession. This hurt the assets. However, in July, the markets decided enough was enough. They thought the Fed had done the lion’s share of the job on inflation; they were calling for a peak in price rises and interest rate cuts in 2023. We disagree, but risk assets nonetheless rallied. Central bank prices were not the only driver, however: the pessimism surrounding China seemed to have bottomed out; Russian gas has started up again; and revenues could have been much worse.

When positioning for what’s to come, patience is key. That’s because there’s still a lot to decide: markets need to wake up to the hawkish sound of the Federal Reserve’s drum (ie, they need to price in a lot more bulls); the 2nd quarter results season must end; and the war between Russia and Ukraine needs a clearer solution. In such an environment, preservation of capital is essential to cash overweight is a prudent strategy. We stick to this point of view.

Elsewhere we stay underweight government bonds, favoring short durations (say up to five years). This shouldn’t be a surprise; we believe the market is undervaluing Fed hikes since February. If they raised the fed funds rate to 8%, as Dominica envisages, a recession would almost certainly ensue in 2023 and stocks would face further declines. Therefore, we also remain underweight stocks.

As the energy crisis drags on and supply chain issues persist, we remain neutral raw materials – they are always volatile, and it is better not to choose a directional bias, even if John sees advantages for agriculture. We are too crypto neutral – in particular, bitcoin neutral-bearish and ethereum bullish.

Finally, in terms of equity sectors, here are our favorite views:

  • In the US, we prefer to overweight Financials, Homebuilders, Large Cap Value, Reopening Trades, Semiconductors, Traditional Infrastructure and underweight Large Cap Growth, Consumer Discretionary, materials and technology.
  • In Europe, we like to overweight renewables.
Bilal Hafeez is the CEO and Editor-in-Chief of Macro Hive. He spent over twenty years doing research at major banks – JPMorgan, Deutsche Bank and Nomura, where he held various “global head” positions and researched currencies, rates and cross-markets.

(The commentary in the above article does not constitute an offer or solicitation, or a recommendation to implement or liquidate any investment or to engage in any other transaction. It should not be relied upon as the basis for any decision investment or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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