05 Jun 2023
Markets have become clouded with uncertainty in 2023. Many asset classes lack clear direction, which makes short-term asset allocation decisions challenging. We therefore identify three key themes that global investors should consider in the nearer-term horizon (1-3 months).
In most major markets inflation shows signs of having peaked. This has been a key driver of risk asset returns in recent months, with equity markets in particularly rallying on the basis that central banks have successfully controlled inflation without stifling the economy. However, the question for investors going forward when determining their asset allocation is the speed and smoothness with which inflation falls back down to what central banks consider to be a normal level, i.e., 2%. While energy and goods-related inflation has declined since mid-2022, service sector and food inflation, which now makes up 85% of total headline inflation in the US for instance, has continued to rise. Typically, services inflation is considered to be ‘stickier’. In other words, the basket of service prices is less reactive to rising interest rates set out by central banks, mostly thanks to. low unemployment and higher-than-expected consumption.
This leaves central banks, markets and global economies in a catch-22 position. If service sector inflation remains stubborn, central banks may have to be more aggressive in raising rates and it may take longer to achieve monetary policy normalization. Central banks have continued to remind markets that their decisions are data-dependent. This was evident in some of US Federal Reserve Chair Jerome Powell’s recent comments to Congress, where he told the hearing panel that a more aggressive approach to rate hikes would have to be considered if inflation does not cool. Just a month earlier he said that “the disinflationary process has started” in the news conference that followed the Fed’s February meeting. The uncertainty in the Fed’s future path has meant equity markets have become overly obsessive with every single economic data point, sometimes reacting sharply to what monthly releases of employment, consumption and inflation data may ultimately mean for monetary policy going forward. Rates markets have been equally volatile, trading in no clear direction. At the end of December 2022, US interest swaps showed traders were predicting a peak US rate of 4.9% in 2023 with two 25bps cuts the same year, but early March predictions of peak rates had risen to 5.5%. Only two weeks later, on 14 March, markets went back to pricing in a 4.9% peak rate, given the ongoing bank crisis.
We do believe inflation will eventually fall to 2% by end-2024, but the path may be slower than expected owing to the stickiness of service sector inflation. Consequently, central banks will have to keep rates ‘higher for longer,’ despite early evidence that the impacts of higher rates are already starting to be felt in the banking sector. This means the likelihood of a recession triggered by tighter financial conditions grows, which is a negative for equities. The speed and size of rate increases can cause cracks in pockets of the financial system, where cheap money has created unhealthy levels of leverage, or supported unsustainable business models. At this moment, it is hard to exactly pinpoint the weakest areas. It can take some time for these to come to the surface, but as Silicon Valley Bank and Credit Suisse have shown, these areas will materialize as higher rates persist. We expect that we will remain in an environment with volatility shocks, where you will need to actively navigate markets to avoid or reduce the impact of falling in these financial cracks. Higher quality fixed income meanwhile can offer more protection for investors, particularly when higher rates finally start to bite into economic growth.
The dollar bears emerged from their hibernation in Q4 2022. The greenback, which had been profiting from widening interest rate differentials, had done well in the first half of last year but just like US equities, has become hypersensitive to economic data. The declining inflation figures in the last months of 2022 encouraged a growing belief that the Fed was reaching the peak of its rate cycle and momentum faded accordingly. Spot dollar (DXY Index) declined 9% from the beginning of October to the end of January. The recent upside surprise in inflation however is a reminder of the importance of currency positioning. As mentioned in our first theme, sticky inflation and tight labor markets increase the risk of the Fed reaccelerating the pace at which they hike interest rates in the coming months. While the fall out of Silicon Valley Bank in the US has shown that the Fed’s aggressive monetary tightening may now be working, February’s inflation print of 6% is a stark reminder that the central bank has a long way to go to policy normalization. This is positive for the US dollar, as previous momentum from interest rate differentials had begun to lose steam. The repricing of higher rates in the US leads to more tailwind for dollar investors. As higher rates ultimately increase the probability of a recession and volatility in financial markets, the dollar may benefit further owing to its safe haven status.
Not all regions are battling with the same lower growth outlook as the US and Europe. The IMF continues to predict relatively high growth, particularly in emerging and developing Asia, which can offer attractive opportunities for investors. China’s quick relaxation of Covid-19 rules has led to a sudden rebound in consumption in one of the most populous country in the world and the knock-on effects for the broader region were evident in equity markets. The MSCI Asia Pacific Index had climbed 24% from the beginning of November 2022to the end of January 2023. Still, the following 6% decline in the same market over February shows that as global investors we cannot be over-reliant on China’s reopening alone. Regional equities, particularly technology stocks, remain under pressure from not just local government regulations but also from much wider political issues between the US and China. It is important to identify opportunities within the region that are less at risk from geopolitics but can still benefit from Asia’s return to growth and longer-term global trends. We identify semiconductors as a sector that can benefit. Global semiconductors sales reached their highest ever annual total last year although share prices in general fell in the second half of 2022 as the pace pf sales growth eased amid the wider slowdown. Has the semiconductor super cycle finally peaked? It is true that macroeconomic headwinds have created short-term challenges for the industry; however, we believe many of Asia’s semi-conductor companies, which remain global industry leaders, still have an opportunity to rebound despite the current climate. This is not only due to Asia’s economic reopening, but also to larger megatrends that are already in place. Chips are key to not just emerging technologies like 6G and AI, but also to the automotive industry, the electric grid and climate infrastructure which has seen huge fiscal spend by several major economies in recent years. Chips remain essential to the advancement of global technologies, and therefore we continue to believe semiconductor companies have a place in portfolios and are even more attractive now on lower valuations.
Important disclosures
Disclosures
This material is provided by Aegon Asset Management (Aegon AM) as general information and is intended exclusively for institutional and wholesale investors, as well as professional clients (as defined by local laws and regulation) and other Aegon AM stakeholders.
This document is for informational purposes only in connection with the marketing and advertising of products and services, and is not investment research, advice or a recommendation. It shall not constitute an offer to sell or the solicitation to buy any investment nor shall any offer of products or services be made to any person in any jurisdiction where unlawful or unauthorized. Any opinions, estimates, or forecasts expressed are the current views of the author(s) at the time of publication and are subject to change without notice. The research taken into account in this document may or may not have been used for or be consistent with all Aegon AM investment strategies. References to securities, asset classes and financial markets are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions. It has not been prepared in accordance with any legal requirements designed to promote the independence of investment research, and may have been acted upon by Aegon AM and Aegon AM staff for their own purposes.
The information contained in this material does not take into account any investor's investment objectives, particular needs, or financial situation. It should not be considered a comprehensive statement on any matter and should not be relied upon as such. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to any particular investor. Reliance upon information in this material is at the sole discretion of the recipient. Investors should consult their investment professional prior to making an investment decision. Aegon Asset Management is under no obligation, expressed or implied, to update the information contained herein. Neither Aegon Asset Management nor any of its affiliated entities are undertaking to provide impartial investment advice or give advice in a fiduciary capacity for purposes of any applicable US federal or state law or regulation. By receiving this communication, you agree with the intended purpose described above.
Past performance is not a guide to future performance. All investments contain risk and may lose value. This document contains "forward-looking statements" which are based on Aegon AM's beliefs, as well as on a number of assumptions concerning future events, based on information currently available. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance, and actual outcomes and returns may differ materially from statements set forth herein.
The following Aegon affiliates are collectively referred to herein as Aegon Asset Management: Aegon USA Investment Management, LLC (Aegon AM US), Aegon USA Realty Advisors, LLC (Aegon RA), Aegon Asset Management UK plc (Aegon AM UK), and Aegon Investment Management B.V. (Aegon AM NL). Each of these Aegon Asset Management entities is a wholly owned subsidiary of Aegon N.V. In addition, Aegon Private Fund Management (Shanghai) Co., a partially owned affiliate, may also conduct certain business activities under the Aegon Asset Management brand.
Aegon AM UK is authorised and regulated by the Financial Conduct Authority (FRN: 144267) and is additionally a registered investment adviser with the United States (US) Securities and Exchange Commission (SEC). Aegon AM US and Aegon RA are both US SEC registered investment advisers.
Aegon AM NL is registered with the Netherlands Authority for the Financial Markets as a licensed fund management company and on the basis of its fund management license is also authorized to provide individual portfolio management and advisory services in certain jurisdictions. Aegon AM NL has also entered into a participating affiliate arrangement with Aegon AM US. Aegon Private Fund Management (Shanghai) Co., Ltd is regulated by the China Securities Regulatory Commission (CSRC) and the Asset Management Association of China (AMAC) for Qualified Investors only; ©2022 Aegon Asset Management or its affiliates. All rights reserved.
Adtrax: 5704605.1.
Exp. Date: 25/05/2024