Asset Allocation Update – Too Rich for a Recession

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As markets continue to oscillate between worries about recession and concerns about persistently high inflation in the wake of the annual Jackson Hole central bankers’ conference, we note that US bonds and equities have moved a lot in parallel. Notably in Europe, our valuation frameworks now point to a considerable decline for equities.

U.S. Equity and Fixed Income risk premiums have recently reached similar levels, but are around 100 basis points below their June level. Movements in fixed income securities were somewhat limited by the tightening of US yield spreads.

In equities, earnings expectations have remained (surprisingly) stable. Valuations look rich in the context where trend earnings are and should be at this stage of the cycle.

For example, a return to trend earnings for US equities would indicate a 20% decline in total returns; a move halfway up the trend would suggest around -12%. Whereas after a correction, the technologyNasdaq heavy the index now looks less bubbly, also relative to the broader US market, we believe the segment remains particularly vulnerable in a rate hike scenario.

Within stocks, China and Japan are the outliers. Attractive valuations mean we favor them. In a context of caution on Europe, we are globally neutral on equities (see table below).

With respect to fixed income securities, the UK is arguably in the “eye of the storm” of runaway inflation and associated political pressures. The UK Bank Rate is now expected to peak at 4.5% in six months, around the same time as the zenith of US and European policy rates. Here, the expected peaks are 4% and just above 2% respectively.

In the UK and US, rate cuts are expected to occur soon after; in Europe, the jury is out on whether the ECB will reverse its interest rate hikes over a five-year horizon.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income from them can go down as well as up and investors may not get back their initial investment. Past performance does not guarantee future returns. Investing in emerging markets, or in specialized or restricted sectors is likely to be subject to above average volatility due to a high degree of concentration, greater uncertainty as less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of developed international markets. For this reason, portfolio transaction, liquidation and custody services on behalf of funds investing in emerging markets may involve greater risk.

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