July 06, 2023
Precursors to a soft landing
July 06, 2023
June was a positive month for global equities, with the S&P 500 Index returning 6.6%1 (USD) and the MSCI Europe (EUR) Index up 2.4%1. The US Federal Reserve held rates steady at the June FOMC meeting2 which drove positive sentiments in the market. The first half of the month saw gains bolstered by technology-related names on the back of advances in Artificial Intelligence. Indeed, a small number of technology stocks have driven the US stock market for the first half of 2023. However, on an overall basis, Consumer Discretionary was the best performing sector this month as the breadth of the market continues to catch up. Japanese equities continue to perform exceptionally well, with the MSCI Japan (JPY) Index returning 7.7%1. The MSCI Emerging Markets (USD) Index also reported gains of 3.9%1. The US 10-Year Treasury yield remained range bound during the month, ending June at 3.81%3. The VIX index reached its lowest level of the year in June, ending the month at 13.63.
We base our proposition of a soft landing on a slowing, but resilient labour market, as businesses in certain industries continue to fill vacant positions and maintain the existing workforce. Services industries were significantly more affected by the COVID-19 pandemic than goods industries, due to lockdowns and job losses and are still in the process of rebuilding their payrolls post-covid. Job opening rates remain higher than pre-covid levels and with robust consumer spending, employers are compelled to retain employees. Real wage growth is projected to pick up in the second half of the year and into 2024. However, this should also help avert a sharp decline in consumption, particularly as the fiscal stimulus from COVID-19 dissipates and tighter financial conditions dampen demand, thereby indicating a soft landing. Furthermore, investors and analysts have started to revise their recession forecasts to either no or late recession this year and the expectation for a mild recession versus a hard landing has increased.
It’s all relative
Chasing the elusive 2% inflation target, many developed market central banks, with the notable exceptions of the US Federal Reserve and Bank of Japan, hiked rates once again in June. Although headline inflation may be slowing, core inflation remains sticky. However, global central banks may choose to balance the risks of growth and inflation. Whilst they may remain hawkish and continue to raise rates, albeit in a gradual manner, this reflects our view that the policy stance is more accommodative than tight relative to inflation, which is stimulative for risky assets but with the inference that inflation could run hotter for longer.
In contrast, emerging market central banks are ahead with their aggressive policy stance, and already having established a good level of inflation control, are now signalling an end to their rate hikes and even a loosening in their policy stance, which is also supportive for risky assets.
The question of whether central banks are able to lower and anchor inflation successfully, or inflation becomes unanchored, is likely to continue to be a major focus for the remainder of the year.
June has been the best month for equities since January this year and while technology-related names drove the gains, we believe that currently, the other cyclical sectors of the market are more stable and undervalued. Bearing this in mind, and the low volatility in markets, we slightly increased exposure to equities in June. We also made the following tactical changes during the month:
We upgraded our view on US equities from underweight to neutral, as fundamentals appear to be stabilising and headline valuations look expensive, this is driven by a handful of stocks. We expect other stocks, which are currently at average or below historical P/Es, to catch up as we move away from the prospect of a hard landing scenario.
We also added to Japanese equities as Japan’s economic recovery continues and returning inflation supports nominal sales growth. We believe there is room for profit margins to recover as production recovers, supply-chain bottlenecks ease and raw material prices normalise.
We closed the position in the Secured Overnight Financing Rate (SOFR) instrument, which we added in the first half of May, as it has already played out with a hawkish stance from the Federal Reserve.
We closed the FTSE MIB position, moving from overweight to neutral on Italian equities as country-specific risk premium has not fully played out for Italian equities, due to the presence of other value opportunities in the region and also as we shift to a more balanced view of the US and European economies.
We broadened out our overweight to the Japanese yen by adding a long position vs the euro. As the yen approaches levels of prior Bank of Japan intervention, we think that further losses are limited, making forward-looking outcomes asymmetric.
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.