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

 

Over the last six months, there have been encouraging developments in US inflation. With no sign of an imminent recession, Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment at global investment manager, Schroders says expectations of a soft landing have been supported and the probability that interest rates in the US have reached a plateau has also increased.

 

Equities

Over the last 6 months, we continued to see encouraging developments on US inflation. With no sign of an imminent recession, our expectations of a soft landing have been supported and the probability that interest rates in the US have reached a plateau has also increased. As a result we upgrade US equities to overweight.

US:

Stabilising bond yields and resilient growth in the US should support this market into year end.

UK:

We upgraded our view to neutral over the quarter. While concerns around stagflation remained, valuations appeared relatively attractive as UK equities had lagged other markets. Better-than expected fundamentals also raised prospects for the market.

Europe (ex UK)

The eurozone purchasing managers’ index (PMI) continued to decline, with manufacturing activity being particularly weak. This, combined with relatively high inflation, was expected to weigh on the performance of the region and so we kept our negative view.

Emerging Markets

We retained our neutral stance. The relatively weak global goods cycle remains a headwind; however, the asset class is likely to be supported by central bank policy easing, given inflation in EM markets is generally lower than in developed markets. 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:

On the one hand, valuations during the quarter appeared relatively attractive, but momentum slowed as doubts over economic growth increased. The market also faces meaningful challenges in the economically significant property sector and so we chose to remain neutral.

Asia ex. Japan

We upgraded to neutral as there was some evidence to show that the global manufacturing cycle had started to rebound, particularly in the tech sector where enthusiasm over artificial intelligence boosted sentiment. This provided a better outlook for countries such as Taiwan and South Korea where tech exports are a major contributor to GDP.

 

Government bonds

We expect yields to stabilise as inflation slides but given that we are not expecting an imminent recession or a Fed pivot, we prefer to get exposure to rates via credit where we are compensated with a better yield.

 

Credit

We maintain our positive view on credit as the asset class offers access to the defensive properties of duration but with some markets, notably European investment grade, generating positive carry compared to government bonds. This month we also upgrade US high yield debt as yields are attractive and a benign economic environment supports this asset class for now.

 

Commodities

We upgraded our view on commodities from neutral to positive in July and continue to own the asset class as a source of diversification to protect against geopolitical risks and the potential for growth remain stronger for longer.

We are neutral on agriculture as crop conditions have improved significantly, providing a buffer on the supply side. El Nino remains a risk but higher yields and good progress in this planting season leave us neutral.

In the case of energy, supply cuts from Saudi/Russia are still feeding into the market but we believe the impact is largely priced , and the outlook for 2024 is for more muted demand growth. However, energy is diversifying in the context of a tense geopolitical situation.

 

Fixed income views

 

Government

We closed our overweight position in the 5 year as, with the Fed on hold, we lack catalysts for that part of the curve to rally. Longer-dated bonds are unattractive due to the yield curve being inverted, and concerns surrounding debt levels and inflation.

In the UK, for most of the quarter we were negative on gilts but upgraded our view to neutral in September, mainly as a result of inflation falling more than expected.

At the outset of the period, we were neutral on German Bunds, but then upgraded our view to positive due to lower inflation and the deteriorating growth outlook.

We remained neutral on Japanese bonds as absolute yields have remained unattractive.

 

Inflation-linked

We remain neutral inflation-linked bonds because of the Federal Reserve’s commitment to curbing inflation and because we see some tentative signs of softening wage trends.

 

EMD

• Denominated in USD: Valuations for USD emerging market debt are expensive. Although  fundamentals remain resilient, these markets are exposed to Chinese growth and the global commodity cycle. Additionally, the light supply of bonds kept technical conditions tight, therefore we maintained our neutral score over the period.
• Denominated in local currency: In July, we were positive on emerging market debt, as declining inflation meant emerging market economies were approaching their inflation targets. Within the asset class, we preferred Latin America due to positive real yields. We maintained this view in August, but switched to neutral in September as we were concerned about the risks to the asset class should the US dollar strengthen.
• High yield (HY): We have upgraded US high yield because the sell-off in yields provides us with a compelling carry opportunity. Corporate and household balance sheets remain strong, standing them in good stead to digest tightening financial conditions and moderate growth without a significant pick up in defaults. In Europe, defaults are starting to increase, albeit from a very low base, so we remain neutral.
• Investment grade (IG) corporate: We kept our scores unchanged for US and European investment grade credit. We retained our preference for European investment grade as we expected it to benefit from the ECB nearing the end of its hiking cycle and from the positive carry. In the US investment grade sector, although corporate fundamentals remained strong over the period, yields looked unattractive relative to cash rates and valuations remained expensive.

 

ENDS