Chapters
Market observations
The two forces influencing markets
Iain Cunningham – Co-head of Multi-Asset Growth, Michael Spinks – Co-head of Multi-Asset Growth
We continue to believe that two primary forces remain underappreciated by financial markets. The first being the extent of the coming slowdown in the US and Europe as these economies look set to suffer the consequences of one of the largest and most rapid hiking cycles in many decades. The second is the prospect for recovery in China after the country experienced recessionary conditions last year.
History does not support a soft landing
On the former, financial markets appear to be discounting a high probability of a soft landing in developed economies, supported by expectations that the Federal Reserve will pivot and ease policy later this year to support softer growth. Our outlook remains more cautious for two reasons: One, inflation is likely to remain stickier than expected due to ongoing tightness in the labour market. Wage growth remains inconsistent with inflation returning to central bank targets.
The figure below demonstrates the unusual situation of a significantly higher number of job openings than there are unemployed people available to fill them. The ratio of these datapoints is nearly two to one.
The inflation dynamic reduces the likelihood that the Federal Reserve will be able to pre-emptively ease policy in response to signs of weakening growth.
Will the Fed give the market the easing it wants?
Figure 1: US job openings vs. unemployed people
Source: Ninety One, US Bureau of Labour Statistics. March 2023.
And two, soft landings have historically been associated with long and shallow hiking cycles, where economic participants have more time to adjust to higher interest rates. The type of hiking cycle experienced in the US over the past year, from 0-0.25% to 4.75-5.0% for the Federal Fund’s rate, has historically been associated with deeper recessions.
US Economy: soft landing? History implies the odds are low
Figure 2: Historic Fed cycles (% over months)
Source: Ninety One, US Federal Reserve. March 2023.
We believe it is also important to remember that this aggressive rate cycle has taken place after one of the longest periods of easy money in history, where capital will have likely been misallocated, and that policy has notable lags until its effects are felt. We expect the full effects of this hiking cycle to be felt in the second half of this year.
The promise of China’s new up-cycle
On China, financial markets have moved to discount a reopening of the economy over the past six months, but investors remain sceptical about the prospect for a sustained recovery in growth and corporate earnings. We would highlight that China’s credit cycle troughed over a year ago and appears to be entering a new up-cycle, while the regulatory cycle peaked a year ago and new initiatives on this front will likely remain quiet until the economy has shown notable improvement. At the same time, there appears to be material pent-up demand and close to 10% of GDP in excess savings, while policy makers continue to add stimulus. This will be important to offset developed market economic dynamics over the next 12 months which are the primary headwind to assets in Asia, in our view.
A bias towards Chinese equities
As a result of these views our strategies remain underweight equities, with a bias towards the Hong Kong and Chinese markets. In fixed income, we remain overweight defensive duration – focused specifically on high grade markets where low interest rates have encouraged households to build up leverage over the past decade, such as in South Korea, Australia, New Zealand, Sweden & Canada. In currency, our strategies maintain a defensive stance and are long reserve currencies (JPY, USD & CHF) vs. the currencies of more economically vulnerable countries (CAD, GBP, SEK, AUD & NZD).
