Too much of a good thing
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We started the year with fears of recession, and we enter Q4-2023 with fears of overheating.
As usual, developments in the US are decisive for global markets, as Europe and China are decelerating. In the meantime, investors continue to experience sharp market movements across asset classes, and we have turned more cautious in our investment recommendations.
- As an illustration, Brent oil prices were down in excess of 10% last week, after having jumped a massive 30% in Q3. But rising geopolitical tensions in the middle east over the weekend are causing renewed upward pressure on oil prices, a strong headwind for bond markets. We know commodities are volatile and this is the reason why we have preferred to play the theme of oil supply tightness with energy stocks in recent months.
The rollercoaster. The US job market report released at the end of last week was again very strong, coming on top of a flurry of indicators leading to the same conclusion: the tightness of the US labour market has become a source of concern with regards to long term rates… Net job creation was massively above consensus expectations, at 336k vs. 110k expected. Previous numbers were also revised up. The unemployment rate stayed unchanged, however.
- On that basis, and on the back of the current market sensitivity to macro developments, we would have expected a strong jump in bond yields and strong selling pressure on the S&P 500/ Nasdaq 100. But in the end, events unfolded rather smoothly, with the US equity market closing in the black at the end of last week, though 10-year Treasuries were still up by 10 bp. Wage growth came in slightly below expectations, a positive.
- Are we seeing signs of bond market selloff fatigue or at least signs of a circuit breaker between equities and bonds? Potentially, but there is no such thing as a sure thing in current markets, especially with oil prices again on the rise due to tensions in the Middle East.
Our take on global markets. "Adaptation is tantamount to survivorship in the physical world" wrote Bill Gross ten-years ago during the taper tantrum. We are not turning bearish, but we have to adapt and to hedge portfolios against the risk that US Treasury yields keep pushing higher. As we wrote last week, risks might become systemic if debt refinancing concerns in 2024 become unstoppable. Our central scenario remains that growth deceleration will assuage such concerns. But, in light of the recent job market report and rising oil prices, it is too early to bet on a reversal in yields, in our view.
Our new asset and equity sector allocation recommendations.
- #1: we have marginally reduced risk-taking in equities but no major turnaround. We switched from slight OW to slight UW, cutting both US equities and European equities by 10 percentage points. On European equity sectors, we have turned more defensive, upgrading Telcos to strong Overweight (defensive value; potential for corporate activity to boost the sector) while maintaining Food and Beverage and Pharma at Overweight. We nonetheless see upside in US and European equity indices into year-end.
- #2: we have reduced bond duration sensitivity and credit risks in the portfolio, cutting EM sovereign credit, Italian BTPs and Gold exposures to zero. We have also balanced investment grade credit exposure between the US and Europe, the former carrying more duration risk. We added to short-dated US Treasuries, assuming the rate hike cycle is over.
- #3: we see downside risks for the EURUSD. With mounting growth deceleration signals in the euro area, it is becoming increasingly likely that the ECB will soften the hawkish stance before the Fed. We now partially hedge our long USD exposure in our asset allocation and keep a 10% net long position on the USD.
Week ahead: the release of US consumer and producer prices for September will be key to quell (or exacerbate) current market concerns over persistently high interest rates. Also, the FOMC minutes from the late September meeting will be available. In China, lending activity figures will help gauging whether the country is experiencing a cyclical upswing.
Asset classes performance (1 week)
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