July 2022 - Monthly House Views
On a thin line
Change in tone by central banks shakes economic prospects. Central banks are increasingly worried by inflation and have yet to fully tame it, creating uncertainty. They continue a challenging balancing act of tightening enough to slow the economy without tipping it into recession – a sweet spot that is shrinking day by day. While worries of stalling economic activity continue to grip markets, they have caused a sell-off in oil markets, pushing prices from $120 per barrel to around $100. While this drop might provide relief to consumer sentiment, it is not enough to meaningfully offset inflationary pressures just yet.
A falling equity market makes valuations continue to look more attractive for the time being: multiples have retracted to their long-term averages in the US, something not seen for well over 3 years. However, analysts' earnings forecasts continue to be strong despite a slew of headwinds facing companies – increased input costs, potential fall in demand for products, persistent covid-related bottlenecks in supply chains, to name a few. It is our view that the forecasts are too bullish currently and are likely to tamper slightly to more realistic levels.
While fears of a recession persist, labour markets continue to look robust as recent data out of the US surprised to the upside with US employers creating 372,000 jobs in June – 7,000 more than expected. As a result, the unemployment rate remains well anchored at a five-decade low of 3.6%. This however spells more trouble for the Fed, as a tighter labour market means more potential wage pressures. Digesting the news, the market consensus turned more hawkish, expecting another 75-basis point hike in the US by the end of July. By year-end, the market currently predicts interest rates to hit 3.5% in the US and 2.75% in the UK.
In uncertain times like these it pays to not panic, stay disciplined, and trust the process. It is currently telling us the following:
The economic outlook remains in slowdown judging by the forward-looking indicators we measure. While this is favourable for risk assets for the time being, the index has been trending downwards for several months and some components that have been bolstering its outlook until now, such as interest rate spreads, might be losing steam in the months to come.
Valuations are neutral, as prices for equities have fallen this year but earnings expectations have remained anchored, leading to affordable if not cheap assets compared to their own recent history. However, analysts’ expectations appear somewhat overbullish given the number of headwinds arising in the real economy.
Momentum for equities remains negative by the 10-month moving-average metric that we favour. This is cause for caution.
Sentiment in markets is overbearish, driven largely by a strong dollar paired with equity outflows. Usually this would be a buying signal but when paired with negative momentum and a precarious economic climate, it is best to not act just yet on this signal alone.
In order to better reflect the risks of a slowing economy and negative momentum in markets we are reducing our risk by moving from Neutral to slightly Underweight in terms of our equity allocation. The proceeds will be held in cash in most strategies to be deployed should any opportunities present themselves. We continue to hold an increased stable of diversifiers such as: cash, government bonds, gold, hedge funds, commodities and a Tail Risk Protection Note. This provides a resilient positioning in the wake of rising volatility and sufficient flexibility to adjust our views should conditions change.
Process and Convictions
In accordance with the applicable regulation, we inform the reader that this material is qualified as a marketing document. CA25/H1/21
Unless otherwise specified, all statistics and figures in this report were taken from Bloomberg and Macrobond on 06/22/2022