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Article | 31 August 2022 | Investments
The most recent US consumer price index showed a slower annual increase, as inflationary pressures eased on the back of lower petrol prices. This pulled annual US inflation down slightly to 8.5% from a four-decade high of 9.1%. While this deceleration in inflation is positive, our sense is that inflation may remain elevated for a longer period, which is likely to keep pressure on central banks to continue raising rates to levels above neutral in most instances. Meanwhile, natural gas prices in Europe jumped as fears returned about a prolonged halt in supplies through a major pipeline, jeopardising an already struggling economy.
The jump in global shares from June’s bear-market lows, stoked by the market’s expectations for a pivot to rate reductions next year has started to fizzle after repeated Federal Reserve policy makers warned that interest rates are going higher. The euro slumped back to parity with the US dollar and European stocks dropped as surging energy prices heightened fears that the region’s big economies would slide into a recession. And Treasury yields spiked as hawkish Fed Chair Jerome Powell triggered a bond market reset, as he pledged to forcefully use Fed tools to bring down inflation.
We continue to have concerns over equity markets, believing the recent relief rally will be short-lived as inflation and interest rate concerns reappear following the summer holiday period. We continue to prefer US and Asia-Pacific equities over European equities, as the region faces a bleak winter ahead. Meanwhile, we are slowly rotating out of Chinese and developed Asia ex-Japan equities, despite being positive about the region’s performance for the medium term, as we feel that the near-term uncertainties will continue to blur the picture.
In terms of equity portfolio construction, we are leaning towards defensive tilts, such as quality and low risk options. We are also maintaining our style neutral approach. While growth has enjoyed a strong recovery of late, the prospect of potentially higher bond yields from here presents a headwind.
For bonds, the summer markets have offered a short period of solace, rallying on hopes of a Fed pivot in 2023. However, we see too much complacency in expectations of a return to central bank support. As a result, we are now less positive on government bonds, seeing more value in investment grade bonds, and remain neutral on the riskier high yield and emerging market bonds.
Elsewhere, we still remain positive on cash, valuing the ability of a cash strategy to lower risk in turbulent markets. However, we have become less positive on alternatives, given the reduced potential for delivering uncorrelated positive returns. This is particularly true due to the difficult environment created by higher volatility in equity and government bond markets.
Look out for further updates.