Dear Investors,
An improvement in the near-term global economic outlook in February caused markets to price in expectations that rates would need to remain higher for longer in order to bring inflation back towards target.
Bonds struggled as a result, while receding hopes of a rate-cut-induced rally weighed on equity markets.
Yielding curve movements
The first two months of the year by DBS have been characterized by a reassessment of global economic conditions by both markets and policy makers.
Recessions seem more distant, and the path of ongoing disinflation looks flatter.
But the markets continue to question the capability of economies to absorb such interest high rates, keeping yield curves deeply inverted.
Review of markets over February 2023
“After a strong start to the year, helped by falling inflation and hopes of an imminent end to the global monetary tightening cycle, resilient economic data in February led to a move higher in bond yields and a decline in equity markets.”
These are the words by JP Morgan Asset Management
The global aggregate bond index registered a 3.3% decline for the month, reversing much of the positive return recorded in January, while developed market equities were 2.4% lower.
With economic data indicating that a recession may not be imminent, investors reassessed their expectations for both the peak in interest rates and the subsequent pace of rate cuts, as the road back to target inflation could be longer than previously hoped.
The European Central Bank (ECB), Bank of England and Federal Reserve (the Fed) all announced rate hikes at the start of the month, in line with expectations.
The broad message that emerged from the accompanying statements, with some nuances, was that despite the recent decline, inflation remains too high and the central banks’ job is not done yet.
Economic News
The strong economic news included labour market data, which remained resilient with unemployment rates that have moved below their pre-pandemic levels across many economies.
The preliminary release of February purchasing managers’ index (PMI) business surveys also showed an improvement in the economic outlook across the major developed market economies.
The headline composite survey rose above 50 into expansionary territory in the US and UK, while the eurozone remained in positive territory too.
The employment components of the surveys were also above 50 in the US, UK and eurozone, confirming that the labour market remains tight, especially for the services sector.
JP Morgan view
We could see some more volatility due to the ongoing uncertainty about the trajectory of inflation and interest rates.
Nevertheless, the current lower level of equity valuations compared to the beginning of 2022 means that markets might be less vulnerable to risks, including a recession, earning downgrades or higher interest rates.
Global Equities
The risk-reward proposition for global equities at an index level is not particularly attractive.
Importantly, US stocks still account for nearly 60% of global equities and are richly valued while also displaying negative earnings revisions.
UBS Asset Management are more optimistic on global economic activity than consensus for 2023, but there are better ways to express this view than through equities at the index level.
Non-US developed market equities
There is a lot of variation between DM equity markets based on differing domestic policy stances and degrees of vulnerability to external headwinds.
We have high conviction that the yen will appreciate, which diminishes the attractiveness of Japanese stocks in local currency terms.
Success in securing natural gas and a mild winter reduced left-tail outcomes for European equities.
However, the ECB is committed to bringing policy rates well into restrictive territory amid a soft patch in activity, which should limit how much valuations can improve or how strongly Europe’s economy can rebound.
Currency update
UBS Asset Management believes the recent move higher in the US dollar is a countertrend rally, and not a return to its 2022 peak.
We have transitioned to an environment in which the USD is rangebound to lower, in our view.
The sustained USD depreciation (Fed tightening cycle over, fading energy pressures on Europe, and an end to China’s zero-COVID-19 policy) are increasingly taking shape, though the first one has been undermined by the strength of US activity and inflation data in early 2023.
A good landing
The best-case scenario would be that one where inflation continues to recede while economic growth and employment continue to stay positive.
However, given what we’re seeing on the horizon, Charles Schwab suggests investors should be cautious about risk-taking.
More turbulence is likely over the next few months.
Overall, whether it’s a hard or soft landing, yields are likely to decline.