Asset Allocation November 2022

Jan Willem Verhulst
CIO

Asset Allocation November 2022

21 November 2022

The highlights this month are:

  • Optimism among equity investors premature
  • Earnings season contains little guidance for equities
  • Reduced underweight in Eurozone government bonds

Global stock markets experienced a strong rebound from oversold conditions in October, breaking a two-month losing streak. Gains were broad-based in developed markets, with the MSCI All Country World Index returning 6%, the S&P 500 up 8% and the STOXX 600 up 6.3%. The main exception to this positive trend was China, with the MSCI Index correcting 16.4% over the month, as investors felt disappointed about the outcome of the 20th Party Congress. Xi Jinping’s even tighter grip on power and lack of willingness to temper the zero-Covid policy unnerved investors. 

The strong recovery in equity markets may appear astonishing given the existing headwinds. While Investors were attracted by comments from some Fed officials that considerations had started over pausing interest rate hikes, inflation data on both sides of the Atlantic has not supported the notion of an impending shift to a more dovish posture by central banks. The U.S. Core Consumer Price Index (CPI) was up 6.6% YoY, reaching a 40-year-high. Meanwhile, European inflation for October climbed to a record 10.7% YoY, mainly driven by energy and food prices. At the time of writing, U.S. CPI data for November was released, showing prices rose slower than forecast (Core CPI 6.3% YoY).

The U.S. economy grew an annualized 2.6% in Q3, beating expectations of 2.4%, while in Europe, the GDP was unexpectedly up by 0.8%. Signs of a resilient economy are also evident in the unexpected increase in job openings in the U.S. with roughly 1.9 job openings for every unemployed worker. Under these circumstances, we believe a pivot from the Fed is far from guaranteed. Bond markets seem to agree as yields continued to move slightly higher in October and future markets are currently pricing a peak in the Fed funds rate of around 5% by May 2024.

That investors can find some relief in an earnings season with the lowest earnings growth rate in two years, is indicative of how much negative sentiment has surrounded markets. The general conclusion of this earnings season was one of relief and reassurance, with company reports allaying initial fears of an impending “earnings cliff”. The picture that emerged from earnings season was not great, but it was not terrible either. However, we think consensus earnings forecasts for 2023, which point to 5% earnings growth globally, do not appear to factor in the potential negative consequences of tight monetary conditions. The most prominent economic leading indicators (ISM, PMI) continue to point to a slowdown in economic activity in both the manufacturing and services sector. The PMIs of the four large eurozone member states undercut the already pessimistic market expectations in October. Production and order intake have slumped more sharply than at any time since the survey began 25 years ago.

Economic growth and earnings will most probably further decelerate into the start of the new year. And major central banks are expected to continue their interest hiking cycles until the end of the first quarter 2023 albeit at a slower pace. Against this backdrop, we doubt that the conditions for a sustained equity market recovery are already in place and stick with our underweight in the asset class. Given the attractive absolute yield levels and the transition of focus from inflation to growth risks, the risk-return ratio of the more defensive higher-quality segment of the bond market has become more appealing, we believe. We have therefore decided to increase our government bond exposure at the expense of cash.

Please find enclosed our Asset Allocation update for November.

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Jan Willem Verhulst
CIO