Asset Allocation Focus in Autumn 2022

Communications

We expect elevated demand for online services to fall back and consumers shift their spending habits. Digital advertising growth is also expected to slow versus 2021 as marketing spend moderates and instead corporates review discretionary spend in the face of rising geopolitical concerns.

Consumer Discretionary

Consumer sentiment has deteriorated rapidly  with rising energy and food prices undermining consumer confidence and savings buffers have been eaten into; hastening a switch from discretionary spend towards more essential everyday spending.

Consumer Staples

Consumer Staples businesses tend to be of high quality and more economically resilient during market turbulence. Sector valuations look fair in the context of history and whilst the sector faces rising input cost inflation we have seen evidence of inflation pass-through to customers.

Energy

Longer term ESG considerations have fallen to the back of investors' concerns as the Ukrainian geopolitical situation has forced investors to focus on short term supply. With energy prices heavily correlated to GDP, we have become less constructive on the performance of the sector. Capital returns to shareholders should nonetheless remain strong.

Financials - Banks

US banks have enjoyed good performance on the back of strong balance sheet growth prospects and are now retracing as Ukraine delivers a shock to growth expectations and margin expansion. Higher inflation is likely to tame demand, reducing the need to hike interest rates. European banks are more exposed to Russia and suffer from large national debt and higher rates driving declines in their loan books. Margin expansion expectations for UK banks has been lowered given the diminished growth outlook.

Many names are high quality but valuations are not at a level to turn more positive.

Life insurance companies benefit from a steepening yield curve but with higher rate expectations softening, we think neutral remains the correct stance.

Demographic tailwinds and relative resilence of global healthcare spend mean this is a sector with growth and defensive attributes. Valuations have become stretched in growth names and those which have benefitted from the pandemic. However, a greater weighting is to those negatively effected by the pandemic i.e. elective surgery names. Such companies still offer reasonable valuations, defensive earnings and enouraging long-term growth outlooks. 

Global industrial production forecasts, although still positive, have fallen in recent months as supply chain disruptions and heightened cost inflation pressures weigh on broader economic growth.

Valuations contracted over the past year but are now more reasonable. We take confidence from the resilience of technology names whose products are being classed as non-discretionary by consumers and businesses. 

Majors with solid balance sheets should continue to pay strong dividends. The short term outlook is clouded by weakness in Chinese demand, driven by the property market crisis. Recession fears now cloud the outlook which historically led to reduced demand for commodities. The other big issue is input costs, although this problem is baked into consensus numbers. Longer term we remain bullish on energy transition metals e.g. copper. 

Global real estate may offer better value than other fixed income instruments but rising rates can feed through to mortgage rates, with the subsequent fall in demand for real estate hitting property valuations.

The sector has some safe haven support, however it is not immune from the slowdown as business customers suffer. Rising power prices are good for producers however the suggestion of windfall taxes to reduce the impact on consumers may keep a lid on this. There is some inflation protection in pricing however rising bond yields could provide a headwind to the sector which is viewed as a bond proxy. 

UK

UK equities appear to trade at a discount to global developed market equities and should hold up relatively better. The UK has relatively more exposure to the more defensive Consumer Staples sector; Financials which may benefit from rising interest rates, as this may increase bank net interest margins; and Energy & Materials sectors which may provide relatively better inflation protection potential. Plus, we expect ongoing geopolitical tensions to keep energy prices elevated. 

North America

Structurally we favour an overweight position reflecting higher returns on capital and strong earnings growth potential. Whilst the US tends to be overweight “long duration” tech and growth orientated sectors which resulted in more valuation de-rating at the start of 2022, we think the US economic growth picture remains more robust than continental Europe. The Federal Reserve continues to hike interest rates to try to tackle inflation but we should caution that economic storm clouds are building.

Europe

We are becoming increasingly cautious on the economic outlook for Continental Europe. The Eurozone energy crisis is a key risk for consumers and businesses and, in particular industrial output into the winter. European equity markets have de-rated through 2022 but we believe energy and food related inflation is likely to further undermine business and consumer confidence that had seen tentative signs of strength in the earlier parts of 2022.

Japan

Japan’s economic recovery has been poor and inflation remains stubbornly low. The Japanese central bank remains highly accommodative as it seeks to break Japan’s deflationary mind-set. Equities don’t look sufficiently cheap given the economic backdrop but the yen could strengthen if US bond yields stabilise or move lower.

Asia Pacific

China’s push for ‘common prosperity’ indicates that the real estate market slowdown is likely to be prolonged. The authorities are punishing the property financing sector whilst seeking to prevent a property crash; this could result in broader economic contagion. Outside of China, excess demand for semiconductor chips is gradually easing but supply chain challenges remain and geopolitical tensions between China and Taiwan could re-ignite problems for global semiconductors.

Emerging Markets

We are neutral overall on Emerging Markets; valuation remains supportive at the index level versus developed markets but, we believe a strong US dollar environment ultimately acts to tightens emerging market liquidity.

Conventional

Inflation, rising energy and food prices and sub-optimal supply chain efficiency suggests further upward pressure on interest rates so we prefer being underweight and in short dated government bonds.

Corporate

Given our overweight equity position, we would prefer to be underweight as spreads are widening and should continue to do so, driven by investor sentiment.

Index Linked

Pricey but a potentially necessary inflation hedge however Inflation-linked bonds prices can fall by more than conventional bonds of the same maturity if interest rates rise.

Cash

Tactically, we favour being overweight cash. Unlike fixed income it is less sensitive to rising interest rates and fairly uncorrelated to risk assets. This is a short term measure as high prevailing levels of inflation will erode the real value of cash over the medium term.

Property

Real estate lies somewhere between equity and bonds, offering up some level of natural inflation hedging.

Alternatives

Equity earnings risk, rising central bank rates, low government bond yields and uncertainty over the ‘transitory’ nature of inflation mean we prefer infrastructure and gold as diversifiers.