Judging by the number of news headlines, the month of May was dominated by the US debt ceiling debate and the associated political positioning. With the deal now done, this mainly serves as a warning of what is to come in the coming election cycle. As we approached the end of the month, the dilemma of sticky inflation and the associated need for central banks to hike rates further was brought back to attention by stronger-than-expected US consumption and PCE inflation numbers. Markets are therefore again pricing additional hikes from the ECB, BoE and from the Fed if not in June, then possibly later. This was also the case before the self-inflicted banking blow ups of SVB and Credit Suisse in Q1. The biggest risk in markets is therefore the monetary printing experiment of 2020-22 which means that it is still very difficult to assess if policy tightening is already overdone or if inflation proves sticky on the way down. We think enough tightening has been done and keep the opinion that one or two more hikes are neither likely to destroy the economy or to re-store the credibility these central banks squandered in 2020-22. The persistently high risk of more severe policy mistakes and high volatility in long duration high grade bonds keeps us positioned with short duration both in our sustainable investment fixed income mandates and in our global fixed income strategies. It also means that we hold shorter than usual duration in the government and high-grade proportions of our multi-asset strategies.
If politics and policy remain slightly depressing, more constructive news has been released in other mega trends playing a significant role in the current market cycle, namely Sustainable Investing and Artificial Intelligence (and Cloud Computing).
Figure 1: Equity index returns show the diverging fortunes of China, ESG and US Tech
It is remarkable that the International Energy Agency (IEA) now expects more investments in solar than fossil fuels this year and a total amount of USD 1.7trn in clean energy investments in 2023 (see: FT Solar power investments to exceed oil for first time, says IEA chief, FT 25.05.2023). As for the artificial intelligence and cloud computing revolution, both revenue and orders from NVIDIA were spectacular. With some of the world’s wealthiest companies, including Amazon, Apple, Alphabet and Microsoft, ramping up cloud capacity, these trends are more tangible than the promises of future profits built into the technology stocks collapsing in early 2021. The same can be said for the transition to a sustainable economy. Here, governments, infrastructure funds, energy companies and EV companies continue to line up investments. It is of this kind of demand, combined with future potential for technological progress, that economic booms are built of. As history shows, such developments are also the foundation on which bubbles can be formed when things run too far for too long. Figure 1 shows that the initial spike was most pronounced in the Nasdaq China Dragon Index: a boom which was effectively destroyed by Chinese government policy, just like the Chinese housing market was. The question remains if the optimism carries the world through the next quarters or if the slump in Chinese manufacturing and housing along with the central bank tightening and declines in German and US manufacturing will drag down the world economy and equity markets. We are ready to move decisively should the outlook change. For now, we are positioned as follows:
In our growth strategies, with up to 100% equities, we hold equity allocations close to maximum levels, with corresponding underweights in high grade bonds. In EDGE Sustainable Growth, these positions are concentrated in the low pollution, high growth sectors, such as IT and Healthcare.
In our balanced multi-asset strategies, we hold equity allocations close to maximum levels and maintain significant holdings of high yield bonds, where yields are currently above 7% in Euros and above 7.5% in the USD market.
Across our Global Fixed Income Opportunities portfolios, we remain close to a maximum allocation to high yield bonds, in both traditional mandates and our mandates with a focus on sustainable and ethical investments, and have a large allocation to the BB segment.
Mads N. S. Pedersen
Managing Partner and CIO