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Article | 16 January 2023 |
Confidence mounted that the point of peak inflation had passed, as readings from the US and Europe came in lower than forecast. Nonetheless, the ‘higher for longer’ message remains top of the central banks’ agenda, despite recommendations that the pace of interest rate cuts should be reined back. An early 2023 slowdown, or even recession, for many economies was accepted as a foregone conclusion, a view bolstered by lacklustre US payrolls and declining PMI data. China proceeded to unlock its citizens from Covid restrictions, despite relatively low vaccination levels, and infection numbers approached a peak in some cities.
Equity markets closed 2022 on a downward trend, with many having touched bear market territory during the year. Global bonds also fell in December, with the German Bund (-4.4%) particularly badly hit, as hopes of more dovish monetary policy were dashed. The Japanese yen rebounded sharply after the Bank of Japan amended its policy, allowing Japanese government bond yields to rise. Meanwhile, the US dollar weakened as gathering signs of a peak in US inflation led to speculation that the US Federal Reserve (Fed) might dial back the pace of future rate hikes.
Markets have begun 2023 in reasonably buoyant fashion, remaining focused on improving inflation dynamics and less restrictive central bank policy in the coming quarters. We sense an element of complacency, however timing any market corrections is never an easy task. As such, we have chosen to maintain a neutral allocation to equities in the near term.
Following the reopening of China’s economy, we have grown more favourable on the Asian region and by extension global emerging markets, in which Asia ex-Japan is now the dominant share. While these markets have already reacted very positively to the news, we believe economic activity will continue to increase and the region is likely to benefit from a period of relative outperformance. In contrast, we look to reduce exposure to US equities. As the environment of elevated inflation, higher bond yields and lower profit projections persists, the growth bias of the S&P 500 index could weigh on performance.
With regard to fixed income, while maintaining a neutral view on longer term interest rate risk, we are becoming more positive on emerging market debt. Prospects in this sector look brighter now, with the Fed in the later stages of its rate rising cycle, the US dollar showing signs of weakening and an improving global trade environment on the back of China’s reopening. In order to balance risks in our portfolio construction we have reduced our exposure to investment grade credit.