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Article | 14 March 2023 | Investments
Chief Investment Officer
Recent US economic data has been stronger than expected. Domestic unemployment is now at a 53-year low, while retail sales and business activity, particularly in the services sector, have accelerated. As a result, core inflation remains well above the official 2% target, which reinforces growing expectations that US interest rates will remain ‘higher for longer’. China reported its sharpest rise in manufacturing data for a decade, as output recovered following the pandemic. The Organization of Economic Cooperation and Development (OECD) remarked that global growth prospects were “slightly brighter” for 2023, but that the 2.7% expansion forecast in 2024 was sub-par compared with its pre-Ukraine invasion projections.
After a very strong start to the year, investor sentiment faded during February as the prospect of near term rate cuts retreated. The MSCI World index delivered a negative return during the month, as did the S&P 500, though both indices still show healthy returns year-to-date. Emerging markets were also weak, led by China, with the MSCI China index correcting by 10.2%. Sino-US tensions, already high, increased during the month and this overshadowed the strong data and ‘China reopening’ story. US bond yields rose, and prices fell, with the 10-year Treasury yield almost at 4%. Options trading on the VIX volatility index increased to their highest level since March 2020, as worries grew that continuing rate rises could lead to a recession.
Markets have continued in reasonably buoyant mood, driven by a combination of improving inflation dynamics and an increasing belief that central bank policy will result in a softer landing, thereby avoiding recession. That said, double digit gains from many markets so far this year could leave them exposed to pullbacks on any disappointing news. Our preference would be to add further to equities in the event of any meaningful correction, so we maintain a neutral allocation to equities in the near term.
Within equities we continue to favour Asia ex-Japan and the Emerging Markets. Following the reopening of the Chinese economy, we believe that economic activity will continue to increase, bringing the region a period of relative outperformance. We maintain relatively less positive on US equities, which no longer have the supportive tailwind of a strong US dollar. In a continuing environment of elevated inflation and higher bond yields, the growth bias of the S&P 500 could weigh on overall performance.
With regard to fixed income, we would expect bond yields to remain reasonably range bound in the near term. While yields could well rise sporadically on hawkish central bank rhetoric, we don’t foresee any repeat of the large moves experienced in 2022. We maintain our preference for both emerging market debt and investment grade credit. Credit spreads over government bonds remain attractive here, and we continue to like the higher interest rate levels on offer in both asset classes.