Insights
Relative developed market labour resilience, despite slower growth
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December 05, 2022
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Relative developed market labour resilience, despite slower growth
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December 05, 2022
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Relative developed market labour resilience, despite slower growth
Relative developed market labour resilience, despite slower growth |
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Global equities rose in November, with the S&P 500 Index returning 5.6%1. In local currency terms, the MSCI Europe Index and MSCI Japan Index each returned 6.9% and 3.0% respectively1. However, emerging market equities far outstripped developed markets, with the MSCI EM Index (USD) gaining 14.8%1. Despite a sharp fall in oil prices, this price action was not reflected in the energy sector, as the MSCI ACWI Energy Index (USD) continued moving higher, returning 3.7%1. Federal Reserve Chair Jerome Powell indicated at month end that “moderating the pace of rate increases may come as soon as the December meeting2.” Combined with the U.S. Consumer Price Index (CPI) move down, at least for now the market appears to see this as positive for risk. Reflecting this mildly risk-on sentiment, the U.S. 10-Year yield, which had been above 4.0% since the second half of October, fell to end the month at 3.7%3. The VIX continued to trend down to 20.63.
Relative developed market labour resilience, despite slower growth
The U.S. labour market appears to be starting to normalise with elevated, but declining job openings, quit rates and wage growth. These indicate the demand-supply imbalance in the post-Covid U.S. labour market has begun to rebalance. In the current environment where excess labour demand is reflected primarily in job openings, jobless claims and by extension the unemployment rate, may prove more resilient. This may support consumption, which should support the economy. In contrast, Europe's labour market appears structurally tighter than that of the U.S., with growing risk of wage growth catching up with inflation, increasing the risk of persistent core inflation. This increases the risk of a de-anchoring of inflation expectations in Europe and subsequently puts a floor on long duration European bond yields. Consequently, we have a slight bias for U.S. over European duration.
Investment implications
Our equity and fixed income allocations reflect our defensive positioning and is broadly unchanged this month. Overall, the outlook for duration has become more balanced recently, given the move down in U.S. CPI[1] and deteriorating macro picture. As we look to 2023, we prefer higher income assets, and U.S. fixed income, with risks tilted to the downside for equity markets and tilted to the upside for U.S. Treasuries. We made the following tactical changes in November:
European Banks Equities
First initiated in September, we have added to this overweight position, as the supporting factors continue to persist, such as the higher rate environment.
Global Energy Equities
We added to overweight global energy equities, as a higher oil price regime is supportive of the energy sector and while re-rating is yet to happen, the upside appears significant.
European Investment Grade Corporates
We moved overweight European investment grade corporates. With all-in yields the highest in a decade, for many developed market investment grade corporates is becoming more attractive. Upside risks to spreads remain in the U.S., but this risk is less severe in Europe.
European 10-Year Government Bonds
In September, we moved underweight European 10-Year government bonds, to reduce duration, as the ongoing energy crisis was likely to force central banks to remain hawkish to cool inflation. We reduced this in November, with German Bund rates moving closer to our 2.2% target, where we would consider adding further exposure and we now see risks are more balanced for them to stay above 2%2. We are keeping the underweight to peripheral European bonds, which have tightened significantly and look vulnerable to widening.
Emerging Market Corporate Debt
We moved from overweight to neutral Emerging Market corporate debt, with the highest risk exposure to Asia and China, which face uncertainty from China's bumpy Covid reopening and property market. The shorter duration profile for EM corporate debt means that the asset class is unlikely to benefit as much from bond yields rolling over, as the global tightening cycle peaks.
Emerging Market Sovereign Debt
We moved overweight Emerging Market sovereign debt, as some EM economies are ahead of DM central banks in hiking rates and arguably have a better grip on inflation. Therefore, their economies and currencies could be resilient and better prepared going into this inflation-induced slowdown. In addition, the asset class has longer duration and highest carry within credit.
Sterling (GBP)
In November, we closed the underweight to Sterling, first initiated in October. Downside risks have diminished greatly due to the change in government and a renewed focus on fiscal stability. Lower energy prices have also reduced stress on the current account and (imported) inflationary pressures. The Bank of England having a more cautious stance on hikes could lead to a less severe recession – a net positive for the UK economy (compared with already depressed expectations) and GBP.
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See Disclosure section for index definitions.
We have provided our tactical views below:
We have provided our tactical views below:
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Managing Director
Global Balanced Risk Control Team
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