We continue to recommend overweighting less rate-sensitive assets such as cash, value sectors, international equities and real assets.
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International Macro Scenario
Recent data support an easing of near-term recession risks, which are visible, for example, through PMI surveys, with an improvement in orders complemented by an increase in employment and a fall in inflation, as well as in that economic data in the various regions have generally been surprisingly upward.
One scenario is soft landingwhere economic growth slows, but remains positive and inflation moderates, would already be largely incorporated.
The U.S. inflation data, while continuing to show a moderation in year-on-year inflation readings, also hinted that this moderation may be less rapid than expected, also hinted that this moderation may be less rapid than expected. Overall, what we continue to see is disinflation still concentrated in the goods market, but with services inflation remaining strong, as we wait for rental inflation to start moderating later in the year.
In addition to consumer price data, producer prices surprised to the upside, January retail sales were particularly strong, and labor market data remain solid. Simply put, economic data in recent weeks have mostly surprised to the upside, reflecting an economy, and in particular demand, that remains quite resilient.
This has continued to put upward pressure on market rates (10-year treasury rates are already approaching 4% again) and expectations for the terminal fed funds rate is already trading near 5.5%, that's 50 basis points higher than just a few weeks ago. And for the first time this cycle, the market is pricing in more hikes than the Fed, and options traders have been piling on bets with a 6% target for September.
Some doubts have arisen about China's reopening process, and the government has urged stronger measures to boost domestic demand and investment.
International Equities
On weighting ex-US markets and value sectors
Much of the equity adjustment during 2022 can still be attributed to "multiple compression" on account of higher interest rates stemming from inflationary pressures, while corporate earnings expectations remained relatively resilient.
Looking ahead to 2023, the focus will shift from valuations to earnings. It all remains a delicate balance between lower inflation and rate pressures vs. deteriorating earnings prospects.
Rate levels limit the expansion of multiples. Dividends and FX return will be the most relevant factors to explain the performance of equity markets.
Earnings begin to correct further downward (with the exception of China) given the more challenging corporate environment heading into 2023.
The recovery in equities - particularly in the US - is not sustainable, with further downward revisions in expected earnings and higher interest rates putting pressure on valuations that are not particularly attractive.
In particular, the outperformance of growth sectors so far this year would not be sustained, in a context of more persistent inflationary pressures and higher interest rates.
Overweight ex-US markets in tactical terms. Trend fed by the weakness of the dollar and the reopening in China. Valuations are more attractive outside the US.
Good entry point for Chinese stocks, after the recent corrections.
International fixed income
Sovereign rates at the short end of the curve have become "quite competitive" with the yield offered by both equities and fixed income.
The cooling of U.S. inflation argues for a reduction in the pace of hikes, not yield levels.
Negative slope, neutral in duration (around 4 years). Add duration as sovereign yields increase.
Overweight IG US. US corporate bonds are attractive based on historically high initial yields. In a recession scenario, falling basis more than offsets rising spreads, which is not the case for HY debt.
Increase exposure to "cash". Risk-free rates on the short end of the sovereign curve have become particularly attractive and can bring not only yield (Treasury Bill 1y are already approaching 5%), and diversification, but also less volatility to the portfolio, at a time when valuations are not particularly attractive in traditional assets.
Regarding Corporate Spreads, the risk/return ratio is not attractive, especially in high yield debt.
US fixed income incorporates low recession risk.
Dollar and commodities
Less dollar, more commodities
Rate differentials become less favorable toward the dollar given the expected larger drop in US rates.. While we acknowledge the progress in inflation, it is still insufficient to deter the Fed from raising interest rates further, so after a 12% drop from October's highs, the dollar remains exposed to short-term rallies.
Just as commodity markets have been dominated by the dollar in 2022, they are expected to be determined by underinvestment in 2023. From a fundamental perspective, the setup for most commodities in 2023 is bullish.
