The global slowdown is now clearly upon us. Less clear is how deep it will be.
Meanwhile, despite encouraging figures in the latest US inflation report, levels remain painfully elevated. These two trends pose a quandary for central banks and governments, as they pursue sometimes contradictory aims. In the United States, the economy is bowling along despite a clampdown in monetary and fiscal policy. While there are initial indicators showing tight financing conditions starting to bite, the labour market remains robust, and savings are sustaining demand. Underlying inflation is taking time to fall, giving the Federal Reserve ample reason to remain vigilant.
In Europe too, central banks persist in tightening policy against a more fragile economic background while governments heavily subsidise households and businesses to try and blunt the impact of the energy crisis. There are two risks here: that inflation may become embedded for the long term and that higher interest rates could make these measures unaffordable.
The UK grapples with the worst of both worlds: its labour market remains the only one amongst its developed counterparts whose employment participation rate has still not recovered to pre-pandemic levels, keeping pressure on wages. Some argue this is still due to Brexit reasons. On the other hand, consumers will feel the increasing squeeze of rising energy costs as winter approaches – an exogenous factor the Bank of England has little sway over. Meanwhile, investors are anxiously anticipating the delayed Chancellor’s Autumn budget as the government aims to reassure markets of their return to a sustainable fiscal policy.
Elsewhere, in China, growth is still likely being hampered by the zero-Covid policy and a struggling property market. Slower Chinese growth is taking its toll on the global economy but is simultaneously helping to bring down energy prices and so contributing to the opposing forces against the prevailing economic and price trends.
Continuing our prudent allocation strategy. We are maintaining our prudent approach to equity markets, retaining our underweight stance overall and continuing our path of reducing exposure to concentrated growth sectors. We have also continued a gradual re-allocation to Government Bonds as bond markets seem to have found a foothold at significantly more attractive yield levels than those of recent history, now providing reasonable income as well as increased levels of protection. We remain cautious about Corporate Debt and especially the riskier High Yield space as the unfolding recession could hold some surprises for the market yet.
In accordance with the regulations in force, we inform the reader that this document is qualified as a promotional document. Unless specified, all figures and statistics in this report are from Bloomberg and Macrobond on 11/11/2022, publication completion date.
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EQUITIES
Caution is still required
Equity markets rallied on expectations monetary tightening would peak in the next few months, however we see such expectations as premature and remain Underweight. We are adjusting our positioning within US equities to further reduce our exposure to Growth-biased sectors and hedged some more USD exposure.
United States. We remain at Underweight on US equities. The encouraging drop in inflation raised investors’ expectations for the Fed to pivot – i.e. slow or halt its rate rise cycle – given the implied slowdown in local and global growth. On the back of this sentiment, markets have posted their best single-day return since March 2020. However, Fed Chair Jerome Powell seems to be looking at inflation above his comfort zone for the foreseeable future and is likely to keep the monetary screws tight. We therefore retain our Underweight and continued to shift away from more growth-biased sectors that tend to be more sensitive to changes in interest rates.
United Kingdom. Despite the political crisis, British capital markets have continued to hold up relatively well since the start of 2022. Because of its sector specialisation, the UK stock market gets a boost from the general rise in commodity and energy prices, although the latter have eased back since the end of northern hemisphere summer. This relatively resilient performance should continue over coming months, despite the common risks to all equity markets and we remain Overweight.
Eurozone. Equities in the Eurozone have been rallying hard since the start of October, rising up to 12% from recent lows on hopes that rising gas stocks and falling energy prices will prevent power cuts this winter. The fading of British political risks has also helped. But inflation is still on the rise in Europe and could persist through 2023, prompting the ECB to keep monetary conditions tight. We remain Neutral.
Despite the political crisis, British capital markets have continued to hold up relatively well since the start of 2022.
Japan. We remain Underweight on Japanese equities. Japanese inflation is relatively low, with underlying price rises below their 2% target. While the world's leading central banks have been hiking rates, the Bank of Japan has stuck by its yield curve control policy, which targets a JGB yield of 0.25%. This policy continues to undermine the yen, which hit a 30-year low in October despite the Bank of Japan wading into currency markets on multiple occasions. The weak yen remains bad for Japanese equity markets and we are therefore taking a prudent line.
Emerging markets. The growth outlook remains challenging in emerging markets, particularly China. The US Federal Reserve’s relatively more hawkish approach has driven down emerging market currencies and the Chinese property sector is looking fragile. On the other hand, South American economies have been benefitting from elevated commodity prices and proactive monetary policy. We therefore remain Neutral on this market.
MSCI 12m forwards Price to Earnings ratio
Source: SGPB, Bloomberg, 27/10/2022.
Past performance does not prejudge future performance. Investments may be subject to market fluctuations, and the price and value of investments and the resulting revenues may fluctuate downward and upward. Your capital is not protected and original investments may not be recovered.
FIXED INCOME
Return to attractive rates
While we remain Underweight Fixed Income overall, we have gradually returned to a Neutral stance in Government Bonds amid a marked slump in global growth. We remain Cautious on Credit, especially High Yield, given deep uncertainties surrounding the economic environment.
SOVEREIGN
United States. Sovereign bond yields dropped markedly from their peak of 4.2% (10-year) following an encouraging slowdown in core inflation figures, which at 6.3% came in significantly below expectations. Nonetheless, the Fed’s job is far from done and, although the expectations towards their terminal rate dropped below 5% (upper band) in Q1-23, rate cuts are not projected before 2024. At the same time, the yield curve remains highly inverted due to the risk of a more pronounced economic slowdown. Against this backdrop of already high rates and a sharp deterioration in the global outlook, we are Neutral on US government bonds (Treasuries).
United Kingdom. British sovereign debt has whiplashed throughout the autumn and the daily volatility index for gilts hit its highest since the series began. Initially, yields on the 10-year note shot up to 4.5% after the announcement of a fiscal stimulus package triggered a political crisis. Yields then fell back once Rishi Sunak became prime minister and committed to a more fiscally conservative line. Overall, although risks remain high given the country’s political instability and broader reliance on external finance, we are Neutral. Much of the adjustment now seems to have happened and the Bank of England seems willing to continue acting as lender of last resort if needed.
Eurozone. Sovereign yields rose last month as central banks tightened policy in the face of still rising inflation. Inflation remains high, 10% in September, or 4.8% once energy and food are stripped out. Even though energy prices have fallen substantially in recent weeks and this, coupled with some government measures, should help counter inflation over the next few months, underlying pressures and second-round effects remain strong. In these circumstances, the ECB accelerated its policy tightening, opting for a second 75 bp hike on all of its rates at its end-October meeting. Markets foresee a terminal deposit rate of 2.5%. The ECB will also disclose information about their balance sheet at its next meeting. As inflation does not yet seem to have peaked, we are Neutral on sovereign debt.
CREDIT
Developed markets. Stable nominal growth and elevated yields seem attractive for the time being, however, we remain cautious given the impending recession. We remain Underweight on Investment Grade credit and strongly underweight riskier segments such as High Yield.
Emerging markets. We remain Underweight emerging market debt. Monetary tightening in developed economies is generally bad news for emerging market assets and risks to growth remain high.
Sources: SGPB, Macrobond, U.S. Department of Treasury 27/10/2022.
We remain Cautious on Credit, especially High Yield, given deep uncertainties surrounding the economic environment.
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk, and you may not get back the amount you invest.
Currencies
Dollar Drops
US inflation data for October came in lower than expected at 7.7% vs. 8.1%, this has given a relief rally to the market and is likely to mean a less aggressive Fed, causing the Dollar to weaken from its highs. Despite the weaker Dollar one has to remember that inflation does remain well above the 2% target so it might be too early to call victory on the inflation front which is likely to keep the Dollar higher vs. other currencies. We are looking to reduce our Dollar exposure and increase Sterling.
Dollar index (DXY). In recent weeks, the dollar has fallen back against major developed world currencies as inflation appears to be tempering. However, the feeble outlook for global growth, harder-than-expected policy tightening by the Fed compared to other central banks and ongoing political risks will continue to buoy the greenback.
EUR/USD. The euro rose in recent weeks, back to dollar parity. Its new-found strength reflects a major drop in European electricity prices driven by higher-than-expected gas reserves and a warm autumn. The speeding up of the ECB's monetary policy tightening was good for the euro.
GBP/USD. The pound surged up and down in the wake of gilt movements, touching all-time lows against the dollar at the end of September 1.03 but has since rallied to 1.17 GBP/USD. The temporary fix to the political crisis and return of a fiscally conservative policy mix allowed the GBP to revive. Falling energy prices also helped the pound, like the euro. Our strategies have profited over the last few years being overweight the dollar. Now, to limit the likely headwind facing an extremely weak pound and the mean reverting nature of currencies, we continue to look to reduce our dollar exposure and increase our sterling exposure.
USD/JPY. Downside pressures on the yen, now at its lowest since 1998, remain significant. The Bank of Japan has left monetary policy unchanged as underlying inflation remains weak. To address downside pressures on the yen, the monetary authorities are instead intervening directly in currency markets by selling dollar assets.
US Dollar has fallen from its peak
Source: Bloomberg, Kleinwort Hambros, Data as at 10/11/2022.
Emerging market currencies. Emerging currencies rose over the month having their biggest jump since 2016. China appears to be easing some of its draconian lock-down rules and the dollar strength could potentially be falling from its peak due to a lower-than-expected inflation number. A slower pace of US hikes may offer some respite for emerging-market assets.
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Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk, and you may not get back the amount you invest.
ALTERNATIVES
Gold shines
Recent months have shown how important it is to have alternative assets in a portfolio. Our hedge funds allocation has performed well despite the market sell-off and gold provided another layer of much needed diversification with its best weekly performance in two years. We continue to hold an allocation to real assets and our Tail Risk Protection Note.
Commodities
Oil. OPEC announced it was cutting supply by 2 million barrels/day to reflect the fall in demand as the global economy slows. This allowed the oil price to stabilise at around USD 90/bbl. If China were to ease more of its lockdown measures this would put upward pressure on Oil. At the same time, a global recession fears would inevitably mean less demand for Oil.
Gold. The precious metal had its best week in more than two years after inflation data cooled slightly meaning a less aggressive Fed. Gold now trades at $1765/oz. A falling dollar is helping gold rise. We remain overweight gold given the general economic slowdown as it remains a good source of diversification in volatile times.
Gold has best week in more than two years
Source: Bloomberg, Kleinwort Hambros, Data as at 10/11/2022.
Hedge funds
Hedge Funds. In unstable market conditions hedge funds can help a portfolio, but selectivity is key. We prefer strategies which hold their own in bear markets, such as Merger Arbitrage, trend followers and Equity long/short. These strategies provide relatively safe, uncorrelated sources of returns from equities. Our hedge funds allocation has performed well over the year and been a great diversifier in our strategies.
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk, and you may not get back the amount you invest.
Other alternatives
Real Assets. We continue to allocate to a diversified portfolio of infrastructure (such as energy storage and efficiency, smart grids, waste-to-energy, air treatment and digital infrastructure) and specialist property assets (including affordable housing, care homes and e-commerce and logistics warehouses). These real assets offer additional diversification from other risk assets such as equities, as well as an attractive income stream and reasonable sensitivity to inflation.
Tail Risk Protection Note. Tail risks are typically understood as unlikely but severe crisis events which shock markets and dramatically impact the value of risk assets negatively. The dot-com bust at the turn of the century and the Great Financial Crisis in 2008 and 2009 are examples of such events. Despite it not performing well over the year, we believe the Tail Risk Protection Note offers our portfolios yet another critical source of safety and complements the existing diversifiers.
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk, and you may not get back the amount you invest.
Important Information – *Please Read*
IMPORTANT INFORMATION – PLEASE READ
This document is provided for information purposes only. It does not constitute and under no circumstances should it be considered in whole or in part as an offer, a solicitation, or a contract. It is intended to be used by the recipient only and may not be passed on or disclosed to any other persons and/or in any jurisdiction that would render the distribution illegal.
It is the responsibility of any person in possession of this document to inform himself or herself of and to observe all applicable laws and regulations of the relevant jurisdictions. This document is in no way intended to be distributed in or into the United States of America nor directly or indirectly to any U.S. person.
This document is intended to report solely on the services, products, investment strategies and opportunities provided by or identified by SG Kleinwort Hambros Bank Limited. The services, products, investment strategies and opportunities described herein may not be suitable for all clients. Potential clients should consult their financial adviser to assess the suitability of any proposed transaction before taking any action.
Financial Promotion
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Some products and services are not available in all SG Kleinwort Hambros Bank Limited branches. Their availability depends on local laws and tax regulations. In addition, they have to comply with the Societe Generale Group Tax Code of Conduct. Furthermore, accessing some of these products, services and solutions might be subject to other conditions, amongst which is eligibility.
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Hedge funds
The document may include funds which have not been specifically approved for sale in the jurisdiction of the recipient. In view of this, special care should be exercised when investing in this type of fund. We draw your attention to the following:
- Shares of this type of fund carry no guaranteed return of capital, which, under certain circumstances, may lead to the loss of your entire investment;
- The investment management methodology implies a degree of risk linked, among other factors, to the use of derivatives, leverage and short selling; and
- The terms and conditions applicable to redemption may continue to expose you to risk during the period between the redemption request and execution (usually prior notice of 45 calendar days before the last business day of the end of each quarter is required but can be longer for some investments).
Some funds are subject to extended redemption periods or a restriction is placed on the amount of withdrawals from the fund during a redemption period. This is known as gating. The implementation of a gate on a hedge fund is up to the hedge fund manager. The purpose of the provision is to prevent a run on the fund, which would impact on its operations. Investors should consider a hedge fund with a gate as illiquid, as withdrawals from these funds are restricted.
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Information herein is believed to be reliable, but SG Kleinwort Hambros Bank Limited does not warrant its completeness or accuracy and it should not be relied on or acted upon without further verification. SG Kleinwort Hambros Bank Limited disclaims any responsibility to update or make any revisions to this document. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. As such, SG Kleinwort Hambros Bank Limited, Societe Generale and its other subsidiaries shall not be held liable for any consequences, financial or otherwise, following any action taken or not taken in relation to this document and its contents.
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This document is issued by the following companies in the SG Kleinwort Hambros Bank Limited under the brand name Kleinwort Hambros:
United Kingdom
SG Kleinwort Hambros Bank Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The company is incorporated in England & Wales under number 964058 with registered office at One Bank Street, Canary Wharf, London E14 4SG.
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Jersey
SG Kleinwort Hambros Bank Limited, Jersey Branch is regulated by the Jersey Financial Services Commission. SG Kleinwort Hambros Bank Limited is also authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the UK. The bank's principal address in Jersey is PO Box 78, SG Hambros House, 18 Esplanade, St Helier, Jersey JE4 8PR. The company is incorporated in England & Wales under number 964058 with registered office at One Bank Street, Canary Wharf, London E14 4SG. Services provided by SG Kleinwort Hambros Bank Limited, Jersey Branch will be subject to the regulatory regime applicable in Jersey, which differs in some or all respects from that of the UK. For UK-resident clients certain FCA protections may apply in addition to those available under the Jersey regime in certain specific circumstances.
Guernsey
SG Kleinwort Hambros Bank Limited, Guernsey Branch is regulated by the Guernsey Financial Services Commission to provide banking services and investment business services and is also registered as a money services provider in Guernsey. SG Kleinwort Hambros Bank Limited is also authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the UK. The bank's principal address in Guernsey is PO Box 6, Hambro House, St Julian’s Avenue, St Peter Port, Guernsey, GY1 3AE. The company is incorporated in England & Wales under number 964058 with registered office at One Bank Street, Canary Wharf, London E14 4SG. Services provided by SG Kleinwort Hambros Bank Limited, Guernsey Branch will be subject to the regulatory regime applicable in Guernsey, which differs in some or all respects from that of the UK. For UK-resident clients certain FCA protections may apply in addition to those available under the Guernsey regime in certain specific circumstances.
Gibraltar
SG Kleinwort Hambros Bank Limited, Gibraltar Branch is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority and is authorised and regulated by the Gibraltar Financial Services Commission in respect of banking, investment and insurance mediation business. The company is incorporated in England & Wales under number 964058 with registered office at One Bank Street, Canary Wharf, London E14 4SG and is registered in Gibraltar under the Gibraltar Companies Act with its principal place of business in Gibraltar at Unit 5.02, Madison, Midtown, Queensway, Gibraltar GX11 1AA. The liability of the members of SG Kleinwort Hambros Bank Limited is limited.
Services provided by SG Kleinwort Hambros Bank Limited, Gibraltar Branch will be subject to the regulatory regime applicable in Gibraltar, which differs in some or all respects from that of the UK. For UK-resident clients certain FCA protections may apply in addition to those available under the Gibraltar regime in certain specific circumstances.
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The UK head office and Gibraltar branch of SG Kleinwort Hambros Bank Limited are covered by the Financial Services Compensation Scheme ("FSCS"). Investors and depositors may be entitled to compensation under the Financial Services Compensation Scheme (“FSCS”) if Kleinwort Hambros cannot meet its obligations, depending on the circumstances of the claim. Most clients – including most individuals and businesses – are covered by the scheme, up to the limit of £85,000 per person. Full details of the scheme are available at: www.fscs.org.uk.
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SG Kleinwort Hambros Bank Limited, Guernsey Branch is a participant in the Guernsey Banking Deposit Compensation Scheme (the “GBDC Scheme”). The GBDC Scheme offers protection for “qualifying deposits” up to £50,000, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any five year period. Full details are available at: www.dcs.gg. For further information about the schemes (including the amounts covered and eligibility to claim), please contact your Private Banker.
Jersey and Guernsey do not have compensation schemes in relation to investment services. However UK-regulated mortgage business conducted by SG Kleinwort Hambros Bank Limited is covered by the FSCS if you were resident in the UK at the time the service was provided.
General
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