Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at Schroders

 

The resilience in growth from neutral to negative in March 2023 has meant that equities have held up reasonably well in the short term, but Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at global investment manager, Schroders believes that valuations are still vulnerable, and earnings expectations remain elevated given their expectations of a slowdown.
Recent events and any reduction in banks lending to companies simply reinforce this view.

 

Equities

We downgraded equities from neutral to negative in March. The resilience in growth has meant that equities have held up reasonably well in the short term, but we believe that valuations are still vulnerable and earnings expectations remain elevated given our expectations of a slowdown. Recent events and any reduction in banks lending to companies simply reinforces our view.

US:

We retain a negative view on US equities. We see the collapse of Silicon Valley Bank in March as a sign that the impact of higher rates is starting to be felt, and we expect to see further signs of slowdown in the economy. Given current valuations, we prefer to maintain a cautious stance on US equities given these cyclical headwinds.

UK:

UK equities have held up relatively well this year as the UK economy has been performing more resiliently than expected, partly helped by an easing of energy prices. However, the persistent tightness of the labour market combined with higher inflation and interest rates are likely to weigh on UK equity prices. We therefore have retained our neutral view.

Europe (ex UK)

Over the quarter, we had upgraded our view on European ex UK equities to positive due to attractive valuations and the potential for positive economic surprises given low expectations. However, we have since downgraded our outlook on the region to neutral. Given investor sentiment has shifted, the increasing emergence of challenges to companies in the face of higher liquidity and risk-off sentiment, we believe that a neutral stance is more appropriate.

Emerging Markets

We have downgraded emerging market (EM) equities to neutral as the combination of persistent inflation in the US and financial stress may, in the short term, put upward pressure on the US dollar and the asset class.  In addition, other EM may not benefit as much from China’s economic recovery this time round as the driver for recovery has mostly been attributed to the service sector, and less around capital investment. With global PMIs still falling, many EM countries may suffer a manufacturing recession. Previous aggregate rate hikes have also continued to weigh on EM growth.

Japan

Valuations are fair and Japan should benefit from China’s reopening, but most of our cyclical models suggest that we are entering a ‘slowdown’ phase of the economic cycle. This poses a challenge for the market given its cyclical nature, and so we remain neutral.

China:

We have retained our positive view as the outlook is decisively better for China after the government’s pivot on zero-Covid policy late last year. The rapid reopening has helped economic activity to improve broadly, with early indications from high frequency data and Purchasing Managers Index (PMI) surveys suggesting service sector activity has rebounded strongly. Cheaper valuations have also kept us positive.

Asia ex. Japan

The region should get a boost from the Chinese reopening; however, positive spill-over effects to other economies may be quite limited. This combined with a global downturn may prove challenging for markets such as Taiwan and South Korea, which typically have a strong reliance on the technology sector.

 

Government bonds

Since the upgrade to positive at the start of the year, we have maintained our overall positive view on government bonds. Higher rates have started to impact growth and economic activity is showing signs of slowing down as the market adjusts to a world of higher rates. Strains in the banking sector, falling inflation and signs of peaking in labour market conditions should allow the Federal Reserve (Fed) to relax its hawkish stance over the next few months.

 

Credit

We downgraded credit from positive to neutral in February after significant tightening of spreads and an increase in cyclical risks. Although spreads have since widened, providing a possible opportunity to buy, we prefer to wait for evidence that spreads have stabilised and greater certainty over bank funding costs before re-entering.

 

Commodities

Our outlook on agriculture remains unchanged. Demand remains robust but increasing supply from both Ukraine and Russia, as well as favourable crop conditions, constrain the potential upside for prices. We have stayed neutral on energy. The quarter saw natural gas prices plummet due to a mild winter and an uptick in supply. We have seen the rebuilding of oil inventories in the US, a slowdown in growth and the continuation of Russian exports, all of which lead us to stay neutral. Our view on industrial metals is also unchanged. Initially, we were pulled in one direction by China’s reopening. However, the lack of any stimulus, combined with more moderate growth targets from China, has weakened the case for the sector. Turning to precious metals, we recognise that weakening growth, easing inflationary pressures and peaking real yields should support gold prices. However, given recent price rises we prefer to wait for better levels to buy.

 

ENDS