The macro economic outlook is not the only consideration

Quarterly Market Overview Q3 2023 | Outlook

The macro economic outlook clearly matters, but trying to estimate what might be priced into markets arguably matters more. Time and again, the challenge for investors is not only to determine the macroeconomic path, but also to understand how markets might react. The key concern at the start of this year had been around the risk of recession, and the timing, duration, and magnitude if it came. Through this year, but especially in Q3, the soft-landing narrative has gained traction but tail risks remain, not least the risk around time lags that monetary policy typically exhibits. While not our central scenario, even in the event that a global recession were to land, the outlook for risk assets would be extremely difficult to forecast due to three factors: difficulty timing the start of the downturn given the current resilient economic growth data, difficulty assessing how deep any downturn would be and lastly, whether equities might in fact welcome a recession if it were to meaningfully bring down inflation and interest rate expectations.

While we are mindful of the recent uptick in energy price inflation, recent inflation readings, while bumpy, have on the whole continued to point to a disinflationary trend. It is too early to say where inflation will settle, however the month-on-month inflation readings suggest with increasing confidence that peak inflation is behind us. Crucially, for our forward-looking investment strategy settings, we know that we do not need to wait for inflation to fall back to target before we see a corresponding performance across risk assets. Indeed, from longer-dated studies, historically a disinflationary backdrop, as economies transition between inflation regimes from ‘high inflation and rising’ to ‘high inflation but falling’, has typically boded well for relative equity investment performance. With global equity forward-looking Price/Earnings Per Share valuations around their historical thirty-year average, we are, in aggregate, modestly overweight equity risk relative to our strategic asset allocation ranges.

Within equities this year we have seen rapid swings between market optimism and pessimism around inflation and economic growth. As such we have maintained our equity barbell investment approach with an equal weighting between value and growth investment styles. To us, the amplitude and frequent rotation of change of investment style leadership post pandemic is an important reminder of the advantage of our barbell, first introduced at the beginning of 2021. That said, we continue to take conviction views within our global equity allocations, giving regional and country granular guidance.

Within fixed income, to manage interest rate sensitivity we have maintained a short-duration fixed income positioning during Q3, with a preference for shorter dated (three-to-five year) weighted average maturities. Following confidence in the maturity of the current interest rate hiking cycle, we lifted our sovereign exposures earlier in the summer such that we now have an equal balance between sovereigns compared to corporate credit. Within credit, we prefer investment grade over high yield however, wary that the yield premium for the latter is not in our view providing sufficient reward for the additional risk.

Finally, within alternatives, we have recognised for some time now that income is back in fixed income. As such, earlier this year, in order to fund our increased fixed income allocations we lowered weightings to alternatives such as commercial property and alternative income. Balancing this, we continue to have exposures to structured return products which provide diversification to our expected returns across more vanilla equity and bond asset classes.

To repeat our opening introductory message, as we weigh up the investment outlook, the challenge for asset allocation is how to take a calculated position so that we keep exposure towards more than one economic scenario materialising. Simply, there is not enough visibility currently to decidedly shift our investment weight behind a single expected sustained outcome. Instead, staying invested but keeping balance continues to be our goal, and in turn helping you our clients target your own investment goals.