5 min read 17 Jun 22
Dean Cook, Portfolio Analyst in the Multi Asset Portfolio Management Team at T&IO talks through this week’s latest market developments and T&IO’s current outlook.
Please note that the below is relevant for all Prudential multi-asset funds. The tactical asset allocation comments relate to the LF Prudential Risk Managed Active and Passive ranges.
On Wednesday the Federal Reserve increased interest rates by 75bps, the largest increment since 1994. This came on the back of disappointing inflation data last week which rose to 8.6% from 8.3% the month before. After 5 days of losses the S&P 500 initially responded by moving in to green territory as markets cheered that the Fed had not buried its head in the sand over the inflationary pressures facing society. As comments from the meeting were digested markets swung wildly back in to loss territory: the S&P 500 ending the week down 6.0%; firmly in bear market territory. Atlanta Fed NOW GDP forecasts for Q2 suggest economic growth has flatlined. US retail sales - whilst better than expected - came in at -0.3% for May.
The European Central Bank held an unscheduled meeting to ”discuss current market conditions” as some European peripheral spreads continued to widen against German Bunds. The ECB’s forward guidance indicates it will begin to move interest rates higher this year, maybe as soon as July, and markets have begun to question the credit worthiness of some highly indebted nations like Italy and Spain. The ECB announced it will speed up work on a new tool to tackle this so-called ”fragmentation” in the euro zone. This allayed some immediate concerns with Italian/German bond spreads falling from recent highs of 240bps to 215bps (peak of 550bps in 2011 and low of 6bps in 2005). The Swiss National Bank unexpectedly increased its interest rates by 50bps on Thursday adding to investors jitters on upcoming inflation prints.
The Bank of England followed their US counterparts higher on Thursday, with a fifth consecutive interest rate hike. A rise of 25bps was confirmed, suggesting the Central Bank is trying to combat high inflation without having an overly negative impact on economic growth. Latest figures for April suggest the UK economy is teetering towards recession as it shrank by 0.3%. With UK average earnings at 4.2%, the dreaded wage inflation spiral has yet to materialise, providing policymakers with some breathing space.
America’s Food and Drug Administration recommended that COVID-19 vaccines are approved for babies and young children (~6 months to 4 years) in a reminder that COVID-19 remains a left tail risk to economies enjoying their newfound freedom. The UK Health Security Agency has elevated the classification of new COVID-19 variants Omicron BA.4 and BA.5 to variants of concern as they likely have a growth advantage over the current BA.2 dominant strain. There are early signs of cases numbers picking up in Germany and the UK.
Germany asked its citizens to conserve energy after Russia cut gas supply by 60% in what is seen as a politically motivated move. In an unexpected economic development in the unfortunate conflict in Ukraine, Russia posted Q1 economic growth of +3.5%. With the Central Bank managing to stop inflation and the Rouble from spiralling and Western countries still buying billions of dollars of oil and gas, Russia has managed to stagger forwards. This may reduce the probability that economic collapse would force Russian President Vladimir Putin to back down soon rather than later.
German ZEW Economic Sentiment of -28.0 (prior -34.3) and Current Conditions at -27.6 (prior -36.5) show a mild reduction in economic pessimism.
The recently released UN refugees agency’s Global Trends reports showed over 100m people have been forced from their homes by war and persecution, the first time that figures has hit that dark milestone. The figure has been rising each year for the last decade. Russia’s invasion of Ukraine worsened matters with the situation in Afghanistan and civil war in Ethiopia being other large scale factors. In other news, wildfires in Northern Spain have incinerated over 1,100 hectares of woods amid a heatwave.
Next week we have important inflation prints for the UK followed by the latest PMI data for the US, UK and Europe.
Outlook Central bank hawkishness took another step forward this week, continuing to walk the tightrope of balancing a slowdown in economic growth and a less optimistic economic outlook against a backdrop of stubbornly high inflation. However, medium term market pricing of inflation suggests an expectation that inflation will fall back, eventually, though it is currently unclear whether that is at the cost of a “hard landing” and a potential contraction in output. The economic side effects of the continuing war in Ukraine on energy and soft commodity markets as well as the scars on supply chains left by COVID-19 provide additional complexity and uncertainty when calibrating monetary policy.
We made small changes to our tactical asset allocation with the introduction of an overweight to China equities. Our total allocation to risk assets remains unchanged with China now making 50% of our equity overweight with UK and US being reduced to 25% each. Chinese equity valuations look attractive, there have been some positive developments in their management of COVID-19 and they remain on a different policy trajectory compared to the majority of the rest of the world. We retain a moderate overweight in Alternatives and Property, which we think can act as good diversifiers, less directional in nature, and also to benefit from potential inflation protection characteristics. Where funds do not hold either Alternatives or Property, we maintained a beta-adjusted exposure to equities in its place. The overweight positions are funded by a Fixed Income underweight (rather than partly through cash). Where possible, this is a diversified underweight of UK/US/European Fixed Income (noting that some funds have more limited regional exposures).