Newsletter | January 2024

S&P 500 reached a record high in January (4’931.09) for the first time since January 2022

1.92% THE PERFORMANCE OF THE DOLLAR INDEX

 

Investment perspective

In January, US economic data continued to support the outlook for continued economic strength while disinflation remained in evidence. In Europe, the Eu-ropean Central Bank (ECB) kept interest rates unchanged. On the economic front, the release of the composite Purchasing Managers’ Index beat expecta-tions, suggesting that manufacturing activity is bottoming out. Against this backdrop, asset class performance was mixed over the month. Fixed income indices posted slightly negative returns, with the long-dated gov-ernment bonds posting the largest decline as long-term yields rose, reversing the gains seen in December. US and European 10-year yields were mostly higher as the curve steepened. There was some relief in the US at the end of the month thanks to lower expectations for US Treasury borrowing. As in 2023, high yield corporate bonds, especially European ones, were again the best performers with a return of 1.1% thanks to a significant narrowing of average spread levels (381 bps for pan-European high yield versus 399 bps at end-December). Equities started the year on a weak note before rallying strongly to end the month higher, despite the Fed's hawkish tone at its January meeting and Chair-man Powel's comments that he did not think a March cut was likely. In terms of returns, we observe the same hierarchy as last year, with Japanese equities (+8.5% in local currency) leading the pact, followed by US large caps (+2.5%), helped by some technology names, and finally Indian equities, while small caps (-3.9%), global emerging markets (-4.6% in USD) and China (-10.6%) were the laggards. It is worth noting that the S&P 500 reached its highest level ever dur-ing the month as the "Magnificent Seven" continued their fantastic run. Commodities delivered positive returns with oil gaining ground, with WTI crude up 5.9%, as tensions in the Middle East escalated and disruptions to shipping routes continued. Gold lost just over 1% in US dollar terms after hitting a new all-time high in December, reflecting a stronger dollar (the dollar index rose 1.9% over the period after three consecutive months of decline).

Investment strategy

So far this year, at least in the US, the 2023 laggards are back to lagging and the winners are back to winning as demonstrated by the performance of the US momentum index, which returned 5.6%. Risk asset prices are significantly higher than three months ago, thanks to the Fed's shift from "higher for longer" to "we are done hiking to ease in 2024". However, the timing and pace of rate cuts remain uncertain, as does the path of quantitative tightening (QT). Although the Fed has signalled its intention to cut three times this year, future markets are pricing in more cuts, assuming that the Fed will act faster and more than it has publicly signalled. Long-term interest rates in developed markets have peaked and offer attractive yield levels. Although interest rate cover has started to deteriorate, corporate fundamentals are starting from a position of strength. As credit spreads have tightened, we should therefore expect that future total returns to be driven mainly by carry rather than spread tightening. After the rally since the end of October, it is time to trim the sails by gradually reducing the directionality of our exposures and building up some liquidity reserves to take advantage of any opportunities that market volatility may present.

 

Pan-European high yield yields are still above 7.6% and spreads are actually tighter (381 bps) than a year ago

 

Portfolio Activity/ News

Our positioning since the end of October has allowed us to participate to a large extent in the rally in the last three months. Aware that credit spreads are tight, we are nevertheless maintaining our credit exposure, particularly in high yield, while favouring greater selectivity and quality. We maintain a generous equity weighting in our portfolios, but recognise that greater caution is undoubtedly warranted. We are gradually reducing our equity market positions by a few percentage points and reintroducing long/short strategies into our US equity portfolio. In both Europe and the US, we continue to favour a bias towards quality growth, without ignoring the potential benefits of value. We remain constructive on small caps, particularly in Europe and Switzerland. Although our call on China has proved painful so far, we are maintaining it and taking the opportunity to bring this weighting back to the desired level after the downturn. Finally, our allocation to liquid alternative strategies will reflect our less directional approach to markets by reducing our high beta investments in favour of less directional strategies. We will also introduce an alternative trend strategy to complete our alternative bucket, with the aim of adding further resilience to the overall portfolio.

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Outlook 2024

Executive summary

The year 2024 will be marked by the continued normalization of monetary policy around the world, heightened geopolitical tensions and uncertainty about the decline in inflation.

Rising interest rates and bond yields have fundamentally changed the basis for all investment decisions. This paradigm shift will favour bond investors, who will benefit from higher expected returns, but will further weaken highly indebted actors, especially governments.

Although interest rates have peaked, structural inflationary pressures, such as rising protectionism or the energy transition, will certainly increase the risk of higher inflation than we have seen in recent decades.

As we enter 2024, undoubtedly a year of transformative change, investors' agility will be an asset in seizing the opportunities that volatile markets will offer in the quest not only for wealth preservation but also for real growth.

Economic Outlook

Slower growth ahead but still slightly above potential

US growth to outperform developed peers

China growth upgraded to 4.6% in 2024

Headline inflation falls in all G10 economies except Japan

Core inflation has also fallen, but at a slower pace

Developed central banks have reached the end of their hiking cycle

Monetary policy normalization underway in Japan

 

Best Investment Opportunities

High nominal and real yields provide a means of locking in cash flows

Front end of curve attractive due to flat yield curve beyond 3 years

Interest rate cuts make cash less appealing

Emerging market corporate debt offers attractive carry

Yields of around 8% for high yield are rare and followed by double-digit returns

European equities set to outperform US equities

Small caps or equal-weighted index trading at significant discount to large caps

Favourable risk/reward profile for Chinese equities

 

Key Risks

Rising inflation could delay central bank rate cuts

US consumer spending slows sharply

China’s economic woes persist

Unchecked geopolitical tensions and conflicts

 

Table of contents

  • OUTLOOK 2024: EXECUTIVE SUMMARY
  • A BRIEF REVIEW OF 2023
  • RESILIENT GLOBAL ECONOMY IN 2023 WITH DIVERGENCES
  • OUTLOOK FOR 2024
  • INVESTMENT CONVICTIONS FOR 2024
  • ASSET CLASS VIEWS

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Newsletter | December 2023

S&P 500 and Nasdaq both posted their biggest monthly gains since July 2022

10.7% THE PERFORMANCE OF NASDAQ COMPOSITE

 

Investment perspective

November saw broad-based gains in bond and equity markets on the back of slowing inflation and easing interest rate pressures. As expected, the FOMC left interest rates unchanged, although Chairman Powell indicated that the Fed would raise interest rates if warranted by the data and economic conditions. The latest release showed that the US economic activity had slowed, with mixed consumer activity due to higher price sensitivity.

Fixed income markets, particularly those with high interest rate sensitivity, reversed course after three months of declines and posted broad-based gains. The US 10Y ended the month at 4.34% (it reached 5.02% in October), down 80 bp from its peak but still higher than in January, while the German 10Y ended the month at 2.45%, 10 bps lower than at the end of 2022. The recent release of lower-than-expected preliminary eurozone CPI for November, which rose 2.4% y/y, slowing from 2.9% in October, acted as a catalyst.

Strong gains in the government bond sector, e.g., US Long Treasury up 9.16%, were accompanied by a tightening of credit spreads, which helped all credit segments. For example, the US dollar hedged Global Aggregate Index gained 5.7%, the Global Aggregate Corporate and Global High Yield gained 4.7% and 5.4% respectively, while the EMD High Yield gained 6.1%.

Consumers ended the month better than expected, with Black Friday online shopping estimated at a record $9.8 billion, Cyber Monday sales estimated at a record $12 billion and total Thanksgiving sales estimated at $38 billion. In this context, the All-Country World Equity Index rose 8.1% in local currency terms, 9.2% in US dollar terms and only 5.8% in euro terms. Breadth improved significantly in November. In the US, the large cap index was up 9.1%, while the tech heavy Nasdaq 100 was up 10.7%. Europe, Japan, and emerging markets gained 6.4%, 6.0% and 8.0% respectively. Within Europe, it is worth noting that the small cap index strongly rebounded, rising almost 9% in euro terms.

The US Dollar Index (DYX) was under heavy pressure and closed 3% lower, the Emerging Market Currency Index gained 2.8% and the Chinese Renminbi gained 2.5%. West Texas Crude Oil ended the month down 6.2% while Gold gained 2.7% over the month. The equity volatility index (VIX) fell to 12.9%, its lowest monthly close level in 2023.

 

Investment strategy

October’s CPI confirmed the disinflationary momentum, with the annualized core CPI at its lowest level since September ‘21, while the core PCE fell to its lowest level since March ‘21.

The release of better inflation data came as a relief, allowing the US 2-year Treasury yield to fall 35bp to around 4.7% and the US 10-year yield to fall 55bp to around 4.35%. The rise in interest rate contributed to a significant easing in financial conditions amid growing optimism about the end of the tightening cycle.

Since the November FOMC meeting, we have seen a significant shift in Fed funds rate expectations. Indeed, market participants are now pricing in a near-zero chance of a rate hike in December. Despite Fed officials reiterating their “higher-for-longer” message, the market’s median expectation for the fed funds rate at the end of 2024 fell from a high of 4.83% to 4.19% at the end of November.

The potential pivot in central bank policy, positioning and improved sentiment were the main drivers behind the market rally. EPFR flows data showed a net inflow of $40bn into global equities in the two weeks to 21 November. In the US, the 3Q earnings season ended with growth of around 4.8% as at 30 November. The focus now turns to 4Q23, which fell further this month to 2.9% from 8.0% at the end of September, putting the double-digit earnings growth rebound in 2024 under greater scrutiny.

EMERGING MARKET DEBT CORPORATE YIELD-TO-WORST STANDS AT 7.5% AT THE END OF NOVEMBER

 

Portfolio Activity/ News

US indices broke a three-month losing streak, while Treasuries posted one of the best monthly performances on record, with a rally across the curve and some flattening. As highlighted in October, the market rallied strongly on a positioning tailwind that could continue as trend strategies and shorts continue to unwind positions.

We started the month with an overweight position in equities, which we increased during the month with some rebalancing out of defensive strategies such as US long/short and global low volatility in favour of a global strategy that uses a very compelling combination of macro decisions with more traditional bottom-up stock picking as part of the process.

In fixed income, we carried on our gradual increase of our interest rate sensitivity and maintained our constructive stance on credit including our emerging market high-yield corporate debt position.

Similar to our equity allocation, we have reduced our positions in credit long/short strategies and those invested primarily in leveraged loans, which have very low interest rate sensitivity.

Our allocation to liquid alternative strategies has remained broadly unchanged, with a clear preference for risk-parity strategies over trend and global macro strategies, while recognizing that trend strategies may have been repositioned after the rally and could therefore benefit from further upside.

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Newsletter | November 2023

U.S. 10-year yield flirted with 5.0 percent, finishing at 4.93%, down from the high of 5.02%

- 6.8% THE PERFORMANCE OF RUSSELL 2000 INDEX

 

Investment perspective

All inflation metrics have slowed considerably since their peak, but all remain still above central bank targets. Despite this, developed central banks in major developed markets have reiterated their decision to pause monetary tightening cycle, which could mean that we have indeed reached the end of the cycle. Despite central banks pause, the US 10Y yields rose just over the 5% mark and has conditioned market behavior and returns. At 4.93% at the end of October, yields have not been this high since mid-2007. The 2Y/10Y spread finished the month at 16 bps after peaking at over 110 bps in July.

October was a terrible month for financial markets. It was an awful one for eq-uity markets, but also for bondholders across all sectors especially for those with long maturities. The Global Aggregate index hedged in U.S. dollar was down 0.7%, the Global Aggregate Corporate and Global High yield were down 1.0% and 0.9%, respectively, while EMD USD Aggregate dropped 1.5%. As in September, the worst performance was recorded on the US Long Treasury seg-ment with a decline of 4.9% after an 11.8% drop in the 3rd quarter.

The All-Country World index recorded a decline of 2.7% in local currency and more than 3% in U.S. dollar. In the US, the Equal Weight Index fell by 4.1%, while the main index was down 2.1%. In addition to the sharp decline in small-cap indices (-6.3%), we also note the significant and consequential fall in value-style indices (-3.5%) compared to growth indices such as the Nasdaq 100 (-2.1%). European indices started the 4th quarter on the back foot as well, slipping 3.6% in October. Mid- and Small caps materially underperformed large caps with declines of 4.8% and 5.9%, respectively. In U.S. dollar, emerging markets declined by 3.9%, China A by 3.0% and Frontier markets by 5.8%.

The U.S. dollar index (DXY) strengthened marginally (+0.5%) while the Japanese yen continues to plummet to new lows against the U.S. dollar. As is often the case in these risk-off phases linked to geopolitical tensions, the price of gold benefited greatly, rising by 7.3%. More surprising was the 10.8% fall in the price of the West Texas crude oil.

 

Investment strategy

At the beginning of the year, the consensus view was that a recession was inevitable, due to the rise of oil prices and, above all, due to a restrictive monetary policy that saw key interest rates raised at an unprecedented speed and level.

Some nine months later, the latest release of the real GDP growth for the US economy in the third quarter was surprisingly strong, with an annualized growth of 4.9% q/q. The situation is quite different in Europe, where the latest publication confirmed an anaemic growth that is flirting with the levels generally associated with a contraction phase.

After a spike in inflationary pressures in the wake of rising oil prices, the figures published in October showed a decline, which should reassure central banks. As a result, we do not expect any further rate hikes and believe that we have reached the peak of the cycle.

In the US, the long-term interest rates have risen on the back of continued economic strength, particularly in the labour market, which has further postponed a rate cut and the growing need for issuance to finance the budget deficit.

As bond yields have risen in recent month, the asset class should come back in favor with investors. What’s more, reduced uncertainty over the path of key interest rates and falling inflation rates should support both sovereign and investment-grade bonds, which are generally more interest-rate-sensitive than high-yield bonds.

2Y/10Y SPREAD FINISHED THE MONTH AT 16BPS AFTER PEAKING AT OVER 110BPS IN JULY

 

Portfolio Activity/ News

Market developments in October will undoubtedly have tested investors’ nerves, but also important technical supports. The next few weeks will be decisive, as we could either see an acceleration of the downtrend or a major rebound to correct the oversold situation observed on many markets. In the event of a rebound, this could be violent, as such a reversal in the trend for interest rates and/or equity indices would force trend strategies to close their short position in both interest rates and equity markets.

We are maintaining our favorable view on equities, an over-weight stance that we have gradually increased in October, and are continuing to rebalance our bond holdings towards a better balance between interest rate and credit risk.

Within fixed income, we are maintaining our exposure to emerging market high-yield corporate debt, where we believe the carry is sufficient to mitigate country and specific risk of the market segment. In emerging market equities, and more specifically China, we have replaced our greater China exposure with domestic Chinese A shares.

Within our liquid alternatives allocation, we have taken some profits on our trend strategies and now remain neutral on that group of strategies. The proceeds were reinvested in our dedicated risk parity strategy bucket, a strategy that aims to provide an effective and efficient access to a broad set of asset classes including commodities such as gold.

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Newsletter | October 2023

U.S. 10-year yields hit 16-year peak as Fed seen higher for longer

- 7.29% THE PERFORMANCE OF US LONG TREASURY INDEX

 

Investment perspective

As widely anticipated, the US Federal Reserve decided to hold its target rate range steady at 5.25-5.50%, the highest level in 22 years. In their newly released “dot plot”, at least one more hike is in the card this year and that cuts would begin later than previously signaled. The ECB raised rates 25bps to 4% and signaled that it was likely be the last increase. The BoE and SNB surprised investors with their decision to take a break from their rate hiking cycle. As Investors are internalizing the likelihood that rates will stay higher for longer, U.S. treasuries were notably weaker with the curve bear steepening. The U.S. 10-year yield rose nearly 90bps, touching its highest level since 2007. The 2-year/10-year spread, inverted by more than 100 basis points on June 30, before narrowing to 50 basis points by the end of September. In that context, bond markets posted a second consecutive month of declines across all sectors. The Global Aggregate hedged in U.S. Dollar was down 1.7%, the Global Aggregate Corporate -1.9% and the Global High Yield -1.1% while EM USD Aggregate was down 2.3% The worst performer was the US Long Treasury segment with -7.3%. Global equities continued their downward trend, with the All Country World index recording a decline of 4.1% in U.S. Dollar. Contrary to August, developed markets suffered more than emerging markets, with a decline of 4.3% and 2.6% respectively. Major US equity indices were down in September, a month that lived up to its reputation as the worst month of the year in terms of returns. The U.S. large cap declined by 4.8% while the heavy information technology index was down 5.8%. European equities held up better, with a decline of 1.6%, as did Japanese equities, up 0.3% in local currency. Chinese equities were down 2.6% in U.S. dollar while Indian equities were up 1.7% expressed in U.S. dollar. With oil prices recently reaching record highs for the year in 2023, energy prices continue to pose a significant risk to the disinflation narrative. The U.S. Dollar index was up 2.5% while gold was down 4.7%, logging a decline for the second straight quarter.

 

Investment strategy

Several equity indices hit their highs during the third quarter, before declining significantly, reducing year-to-date returns. The road to a soft-landing may be winding and full of diverging signals but hopes for such a scenario remain intact despite a very aggressive monetary policy. Several Western central banks have not raised interest rates further in September even if inflation remains above the 2% target. These announcements would seem to signal the end of the monetary tightening cycle and the opening of a stabilization phase for short-term interest rates. This phase of rates plateauing around current levels is likely to last several quarters before possible rate cuts in the second half of 2024. The main risks of the current soft-landing scenario are either a more severe slowdown in economic activity or continued strong growth leading to a resurgence in inflation. Even if inflation will only fall gradually, we passed the peak a few months ago, and the theme of disinflation is still relevant. Against this backdrop of moderate growth and disinflation, we find corporate bonds attractive, even in the event of rising defaults, as they offer carry with limited interest-rate risk. Like economies, markets are at a crossroads following recent price action that pushed them close to critical technical levels and into an oversold situation that are generally rare opportunities to increase market exposures.

U.S. SMALL CAP INDEX NOW IN NEGATIVE TERRITORY YEAR-TO-DATE

 

Portfolio Activity/ News

Considering that we had reached terminal rates, we tactically increased our equity weighting in September and are maintaining this position.
Our rather cautious stance on long-dates bonds has proved judicious, and we are maintaining this positioning, while recognizing that we could selectively take advantage of any price exaggeration. We remain confident about our short-dated corporate bonds exposure. However, we recognize that even a moderate deterioration in economic conditions because of tighter financial conditions will create some challenges for highly indebted companies, causing default rates to rise. After a phenomenal rally in the first part of 2023, technology companies and, more generally, so-called growth stocks fell sharply in August and September due to an increase in the likelihood of interest rates remaining higher for longer. We took advantage of this selloff to initiate a position in a strategy focused on investing in exceptional growth companies. As a provider of diversification and return in adverse markets, it is interesting to note the very good performance of our alternative strategy bucket. Indeed, our trend-following exposure recorded a positive return of more than 5% in a complicated market for both bonds and equities.

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Newsletter | September 2023

U.S. 10-year yield jumped to 4.34% on growing concerns of supply

- 12.7% THE PERFORMANCE OF WHEAT INDEX IN AUGUST

 

Investment perspective

The resilience of the U.S. economy and falling inflation led to a wider adoption of the soft landing scenario. However, the release of stronger-than-expected figures and a hawkish Fed put pressure on U.S. long rates leading to a number of setbacks in terms of return for risk assets after several favorable months. The U.S. treasuries were mostly weaker with the curve bear steepening, though yields finished the month well off their highs. In that context, bond markets delivered negative returns with the Global Aggregate hedged in U.S. dollar down 0.13% and the Global Aggregate Corporate down 0.4%. The most affected segment was the EMD complex with -1.4% for the hard currency sovereign index and -2.0% for the local currency index. One of the most prominent headwinds facing equities was the backup in interest rates. Global equities sold off 2.8% in U.S. Dollar terms. Developed markets outperformed emerging markets, with a loss of 2.3% versus 6.2%. The U.S. large cap index was down 1.6% while the equal-weight index was down 3.2%, posting their first monthly decline since February. As is often the case, last month’s risk-off environment was felt more keenly by European and emerging market equities, with declines of 2.5% and 6.2% respectively. Among emerging markets, Chinese equities were down almost 9% in U.S. Dollar. The Dollar index gained 1.7%, reversing most of prior two months’ losses. Gold fell more than 2% while oil prices continued their upward trend (WTI up 2.2%). In Europe, the gas prices jumped by 23% due to fear of LNG supply disruptions at plants in Australia. Other commodities posted negative returns. The equity volatility was unchanged at 13.6% while the interest rate volatility (MOVE index) came down sharply and is likely to get a reprieve as we approach the end of the rate hike cycle. According to the State Street Risk Appetite Index, investors’ cash allocation showed the biggest jump over a year mostly at the expense of investors’ allocation to equities.

 

Investment strategy

The U.S. economy proved resilient despite tighting financial conditions. Helped by encouraging signs of easing in the job market, the risk of additional Fed tightening is limited and current yield should be close to terminal rate. U.S. real yield are approaching 2%, the highest since 2009, suggesting that financing conditions are indeed more restrictive and should cool down the US economy. Credit spreads are well behaved and sit at their long-term averages. They could potentially widen if economic slowdown is more pronouned that currently anticipated. However, we do not expect them to widen massively, and even in that case falling sovereign yields would partially compensate for the negative impact of spread widening. Having more S&P 500 equal-weight exposure has been painful
year-to-date. However, the combination of cheaper valuations and some reversion to the mean does give us confidence. We remain positive on Japanese equities due to strong fundamentals, cheap valuations and loose monetary policy. While aware of the risks and challenges ahead, we recognize that the recent market downturn could provide us with an opportunity to temporarily increase our equity to slightly overweighted the asset class, to the detriment of gold.

U.S. 10-YEAR REAL YIELD ARE AT 1.89% - HIGHEST LEVEL SINCE 2009

 

Portfolio Activity/ News

Our asset allocation and portfolio composition remained cautiously positioned during the month, which contributed positively to our relative performance. Within fixed income, we reduced our emerging market debt sovereign and hence duration exposure. We reinvested part of the proceeds in emerging market debt corporate strategy, which offered an attractive risk-reward profile. The recent sell-off in developed market bonds has given us and our managers the opportunity to gradually increase our interest rate sensitivity as measured by duration. We pared back our credit long/short exposure but remained invested in this type of strategy to reflect our cautious stance. In Europe, we initiated a position in a dedicated flexible credit opportunity strategy that provides an exposure to credit with an active duration management expertise. Our U.S. equity portfolio has remained unchanged during the period. It’s important to highlight that our exposure comprises of a significant long/short exposure particularly suitable in the current environment. We pared back our frontier markets position for our European reference currencies and reinvested the proceeds in European or Swiss equities.

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Newsletter | August 2023

THE US DOLLAR HAS ERASED ITS JUNE GAINS AGAINST THE EURO IN JULY

+ 10.4% THE PERFORMANCE OF COMMODITIES IN JULY

 

Investment perspective

In July, fixed income recorded positive returns across all sectors except for the U.S. long-dated Treasury sector (-2.2%), while global equities were up 3.7% in U.S. dollar terms. The key takeaway from July was the broadening of returns. The U.S. large cap index gained 3.1%, while the equal weighted gained 3.4%, beating the market cap weighted index for the second month in a row. The U.S. small-cap index delivered stronger gains with an increase of 6.1% for the month. Typical value sectors posted gains with energy up 7.3% and financials 4.7%, while Healthcare lagged (+0.9). Emerging market equities posted strong returns, thanks to a Chinese equities rebound of +10.8% in U.S. dollar terms. As widely expected, the Fed increased interest rates by 0.25% to 5.25% - 5.50%. In Europe, the ECB also lifted its deposit and main refinancing rates by 25 bps, to 3.75% and 4.25%, respectively, in line with market expectations. The ECB opened the door to the possibility of a pause in September. This dovish shift was probably due to falling eurozone inflation and weaker activity with manufacturing PMI at 48.9 in July. In this context, the U.S. dollar weakened against major European currencies while recording strong gains against the Japanese and Chinese currencies. Above all, the highlight of the month was the strong return recorded in the commodity complex (+10.7) – particularly in the energy sector (+16.0%). Market expectations relative to the path of the Fed’s monetary policy have shifted significantly since the beginning of the year. After its meeting last month, the Fed said that it would watch incoming data and study the impact of its rate hikes on the economy. The terminal rate market expectation currently stands at 5.4% in November and the first rate cut in 1Q-2Q 2024.

 

Investment strategy

Our portfolios benefited from the positive returns recorded across developed equity markets as well as emerging markets, including China. Like many investors, we have been surprised by the strength of equity markets, in the face of rising interest rates. Despite recent market upswing, we are convinced that the full effect of the central bank’s tightening cycle – which, in the U.S. tends to lag economic activity by 18 to 24 months – has yet to be felt across the economy. In addition, the yield curve has in-verted further, which is historically inconsistent with an economic recovery. A key takeaway from July was the broadening of returns and market rotation, marking the second month in a row where the U.S. large cap equal weighted index outperformed the tra-ditional U.S. large cap market weighted index. As the equity rally broadened beyond mega cap technology stocks, the volatility index fell to single digits, which was the lowest monthly reading since December 2019. We reiterate our defensive stance as we see risks building on the horizon that are not fully priced in by the market. In this context, we maintain our underweight exposure in equities with a preference for defensive strategies.

TREASURY YIELD-CURVE INVERSION NEARS MOST EXTREME SINCE 1980s

 

Portfolio Activity/ News

We have kept our asset allocation broadly unchanged in July, but we have done extensive work within each asset class to reflect the market dynamics and rotation. In equities, we took advantage of the recent market strength to reduce our exposure to technology as well as certain others thematics, including U.S. Small Cap Growth, and reallocated the proceeds into the S&P 500 Equal Weight and respective domestic markets across reference currencies. We reduced our positions in multi-strategy hedge funds and reinvested the proceeds into global macro and trend following strategies. Our hedge fund exposure temporarily decreased after the reduction of our event-driven bucket. The proceeds have been kept in cash pending the reinvestment in a risk parity strategy. We pared back our gold and convertible bond positions. Within fixed income, we have gradually increased our existing positions with a preference for flexible managers as uncertain-ties over the evolution of interest rates remain elevated.

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Investment Perspectives 2023 | Mid Year review & Outlook

Executive Summary

Risky assets thrived

After a tough 2022 for equity and fixed income assets, triggered by the rapid pace and magnitude of the hiking cycle initiated by the Fed and ECB, the first half of 2023 offered a relief with strong return of financial assets despite uninspiring level of economic activity in Germany and China. The Government and Investment Grade bonds had a reasonable start to the year while commodities suffered from economic growth concerns. Equity indices posted strong results, but return differences across sectors and stocks were particularly notable. The dispersion within equity markets became particularly accentuated during the second quarter after the markets had given back most of their initial strong performance at the start of the year due to the collapse of a few banks in February and March, reiterating the nasty bite fast rising rates can have on corporate balance sheets.

Narrow equity market participation

Concentrated portfolios exposed primarily to large technology stocks were rewarded. Only a handful of tech shares have been responsible for most of this year’s gains despite higher rates. Indeed, the seven-largest companies in the S&P 500, all tech companies, are up 86% on average year to date!! Meanwhile, the other 493 companies, in aggregate, have barely moved this year. In Europe, technology companies ASML and SAP have been joined by LVMH and L’Oréal as key contributors to the market surge explaining more than 40% of the index return.

U.S. growth resilient, Germany in recession

Early June, the World Bank revised its forecast for US growth for 2023 to 1.1% from 0.5% in January while China’s growth is expected to climb to 5.6%, compared to a 4.3% in January. The modest rebound in activity in China will primarily benefit domestic sectors, in particular services. Euro area GDP growth is now expected at 1.1% and 1.6% in 2023 and 2024 respectively. The key positive change underpinning this revision is the fall in energy prices and abating supply-chain disruptions.

Hawkish tone reiterated by the FED and ECB

The persistence of core inflation has emerged as a key risk as it could lead to more monetary tightening. However, lower energy prices have reduced headline inflation, with positive effects on demand and financial markets. The FED decided to hold rates unchanged in June, but most members agreed that at least one additional 25 basis points (bps) hike will be required by year end. In June, the ECB raised its deposit facility rate by 25 basis points (bps) to 3.5% and made it clear that further rate hikes should be expected at the next meeting in July, while in Japan the Bank of Japan remained dovish and will continue to support the fragile economic recovery despite stronger-than-expected inflation.

Commodities weak again

Commodity index recorded negative returns in Q1 and Q2, making it the worst asset class in our investment universe with -5.0% and -2.5% respectively as energy prices fell as global growth slowed, energy conservation and mild weather helped reducing energy demand, while rapid expansion of LNG capacities mitigated pressures in natural gas market. Prices of base metals eased due to weaker global demand in particular the slower-than-expected demand rebound in China. Additionally, increased metal supply has put additional pressure on prices. In precious metals, gold delivered a positive return (+5.23% in 1H).

Too few equities in risk-on

Our defensive allocation throughout 1H favoured alternative investments such as hedge funds for their ability to seize opportunities in periods of high volatility and to limit drawdowns and gold, which performs reasonably well in periods of stress and inflation. We maintain our relatively defensive allocation with a preference for alternatives at the expense of equities. Our allocation remains well diversified, which should benefit from some inevitable mean-reversion or provide some protection if markets take a turn for the worse.

 

Table of contents

  • EXECUTIVE SUMMARY
  • 2023 – HALF-YEAR: REVIEW OF OUR INVESTMENT THEMES
  • 2023: ECONOMIC AND POLITICAL DEVELOPMENTS
  • FIRST HALF 2023: FINANCIAL MARKETS
  • SECOND-HALF 2023: ECONOMIC OUTLOOK
  • ASSET CLASS VIEWS – 2023 - JUNE 2023
  • SECOND-HALF 2023: INVESTMENT IMPLICATIONS – JULY ASSET ALLOCATION
  • ASSET ALLOCATION GRID

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Newsletter | June 2023

THE US DOLLAR RECOVERED ALL OF ITS YTD LOSSES AGAINST THE EURO IN MAY

+ 36.3% THE PERFORMANCE OF NVIDIA IN MAY

 

Investment perspective

In May most equity markets were rangebound as investors’ attention was gripped by the debt ceiling talks in Washington to avoid a default by the US government. Japanese equities continued to perform well, however, as did US growth stocks, in particular those of companies heavily involved in Artificial Intelligence. European and emerging market equities struggled and ended the month with small losses. While European bond yields were mostly stable, the Treasury yield curve shifted much higher as investors reduced some of their exposure to US debt in view of the risk of a first-ever US default; 2-year and 10-year Treasury yields rose by 40bps and 22bps, from 4.01% and 3.43% to 4.41% and 3.65% respectively. In this context, the US dollar performed well as it recouped its year-to-date losses against the euro, with a 3% return in May. Weakness was observed in commodity prices on concerns over softer global demand; the prices of industrial metals, such as copper and iron ore, fared poorly, as did oil prices, with a barrel of WTI oil dropping by more than 11%.

Market expectations relative to the path of the Federal Reserve’s monetary policy have shifted quite significantly during the last weeks. While there is a broad consensus that the prospect of further interest rate hikes appears to be very limited from now on, markets repriced their expectations in May for the end-2023 level of Fed funds. From a point where three rate cuts by the end of the year were anticipated, markets are now pricing in one rate cut only. This is more closely aligned with the Federal Reserve’s outlook as it has consistently pushed back against the idea of rate cuts this year already.

As often observed in the past, Democrats and Republicans finally reached an eleventh hour deal to avert the first-ever default on US government debt. The legislation that suspends the $31.4 trillion debt ceiling will remain in effect until 2025, when one is likely to face a similar situation once again.

 

Investment strategy

At the onset of summer, we are sticking to our defensive portfolio asset allocation. We remain cautious in view of a slowdown of economic activity, higher for longer interest rates, tighter bank lending standards, and the risk of rising bond yields. Following the US debt ceiling deal, a deluge of Treasury bill issuance is coming; this could drain liquidity from the markets and push bond yields higher which could in turn also impact stock prices negatively. The narrow rally of the US stock markets is also of concern based on past obser-vations. That is why we are also maintaining our diversified allocation. We are seeing some early signs that a rotation might be taking place in the markets. Strategies which have underperformed up to now appear to finally be attracting some attention from investors. It is too early to tell whether these are sustainable trends, but we see good fundamental reasons to remain invested in this way.

YIELD CURVES COULD BE UNDER PRESSURE AS US DEBT ISSUANCE MIGHT DRAIN MARKET LIQUIDITY

 

Portfolio Activity/ News

May was another flattish month for the portfolios as positive and negative monthly returns for the various underlying positions cancelled each other out. The best contributions were provided by the global technology fund, the multi-thematic fund, global convertible bonds, the systematic global macro strategy, and by frontier markets’ equities. For non-USD denominated portfolios, the strong appreciation of the dollar also contributed to the performance. Alternative strategies overall also added to the performance of the portfolios The main detractors over the past month were European value and Chinese equities, emerging market corporate debt as well as the specialty metals fund. As often highlighted, the performances of some indices this year are quite deceiving as they have been driven by a small number of stocks and sectors. The dispersion of performance between the value and growth styles, between small and large caps, between the different sectors, as well as between different regions is striking. As an illustration the spread of performances between our best and worst performing equity funds was over 40% as at the end of May!

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