February Monthly Note
The IMF now expect the UK to be one of the only major economies to enter into recession this year. Government have promised tax cuts to compensate for high inflation and falling economic growth, though it remains to be seen if any of this will come to fruition. Positively, energy prices should be more manageable as gas and electricity both stabilise at pre-pandemic levels.
Further evidence of peak inflation as numbers from the US, UK, and Europe all continued to decline last month. Despite this, central banks have resisted calls to end their rate hiking cycles, preferring instead to press ahead with interest rate increases and quantitative tightening in the hopes this will put further pressure on what is still high inflation as compared with recent history.
The Chinese economy has rebounded strongly following the government’s end to covid restrictions which have seen the domestic economy suffer greatly as much of the rest of the world returned to life broadly as normal. Harsh lockdowns and quarantine requirements have now been lifted following heavy public opposition and protesting. It is unlikely we will see similar restrictions again given the level of public outcry (unusual in China) and so expect to see Chinese growth recover well from here. This is positive for the global economic growth in the near-term.
2023 has continued the recovery in risk assets following what appears to be the peak of inflationary pressure in the US and Europe, having come under pressure last year from higher inflation rates and recession fears whilst central banks began hiking interest rates. Value equities continue to offer more protection against downside threats compared with their growth peers, as they tend to benefit most from strong recoveries after recession and trade on lower earnings multiples. We are taking a more cautious approach to portfolio positioning for a possible recession. We still like selective growth stocks where there remains true innovation and potential for change, especially recent trends in consumer behaviour that were accelerated by the pandemic but prefer value equities on the whole. We also continue to hold our overall equity weighting at neutral. Fixed income has started looking more attractive following last year’s bear market, with yields now at levels not seen in well over a decade. Bonds also remain an important diversifier in our portfolios. With inflation having seemingly peaked, we believe interest rates could begin to head lower as fears of a global recession pick up. Low duration bonds look the more appealing investment still given the level of inversion in the yield curve, along with selective investment grade credit which was hit hard during 2022. Duration will become appealing again as market participants shift their primary concern away from inflation and towards growth fears, however we are cautious in our positioning here. We also hold an allocation to cash to offset some of this fixed income risk and dampen portfolio volatility. We have also been adding ‘alternative’ assets to the portfolios, which offer low-to-negative correlations to traditional asset classes (stocks and bonds) and give the potential to protect during times of significant market volatility, such as we are seeing at present.
The UK market is very value-tilted and despite this year’s positive relative performance is still highly attractive on a valuation-basis. The UK economy has also recovered well from the pandemic, though economic growth is faltering. The main driver of UK equity outperformance will be relative valuations.
There is good value to be found in European equities, however with war on the continent and the ECB lagging significantly in its inflation outlook and response, there are many headwinds on the horizon for the European economy. Despite this, equities in the region are attractive given historic valuation differentials to the US, and financial companies stand to benefit with interest rates on the rise.
The US represents poorer value relative to the rest of the world due to the high proportion of tech companies that still command a multiple far in excess of the broader market, however it also has the best long-term earnings growth and some of the most outstanding quality companies, as well as the most innovative. In times of global stress, the US also tends to act as a safe haven investment, which props up markets. Overall, we are cautious on the US and so are positioned underweight in portfolios. We do believe the US will remain an attractive investment option in the long-term, but with some obvious headwinds making us more cautious for now.
We believe Japan to be an extremely poor environment for equity performance. The Japanese economy is predicted to grow at the slowest pace of all regions, in addition with a declining and ageing population, the prospect of future economic expansion looks unlikely. Thus, we expect poor relative equity performance from Japan. In the short-term, attractive valuations in the region may boost markets, but this will likely be short-lived.
Asia Pacific and Emerging Markets are predicted to see exceptionally strong GDP growth over the several years and with China’s reopening look set to outperform the broader global equity market. Thus, we are comfortable maintaining an overweight position. The more recent remarks from the Chinese government have been positive but must be taken with a pinch of salt. We currently like frontier markets as a more attractive investment option within the emerging markets universe. Typically, market move in cycles and EM vs US performance is no different. We have been in an extended period of US equity outperformance, and we now expect this trend to change in favour of EM stocks.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 1st February 2023, and are subject to change.
The content of this publication is for information purposes and should not be treated as a forecast, research, or advice to buy or sell any particular investment or to adopt any investment strategy. It does not provide personal advice based on an assessment of your own circumstances. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness. Any expressions of opinion are subject to change without notice.
Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.
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