The end of the earnings recession
July has passed and markets have experienced another month of mostly positive returns led by equities and high yield bonds. High grade bond indices, such as the Euro Agg and US Agg, exhibited minimal changes, remaining almost flat. Short-duration government bonds and investment-grade credit delivered positive returns, whereas longer-term bonds continue to experience significant volatility. Euro and USD government bonds delivered negative returns for duration beyond the 7-10-year range. Having reduced equity allocations in our growth portfolios from maximum overweight to positions closer to neutral weights in late June, these strategies continued to perform well through July, thereby adding to their solid risk adjusted returns year to date. Similarly, our more defensive multi-asset mandates have benefitted from their equity positions and an allocation of 20-30% in high-yield bonds. Within our fixed income strategies, we again benefitted from a reduced, but still significant weight in high yield: we hold between 60-70% of the assets in this category.
Through July and into August market progress has been supported by the ongoing improvement in the inflation outlook and the increasing probability of a soft landing in the US, where headline inflation declined from a recent peak of 9% to 3%. Meanwhile, both the ECB and the Fed continued their tightening. Both stated after their July meetings that their actions are now dependent on data. From our perspective, this data dependency best translates as having no clear plan but good intentions and a desire to get it right this time.
Figure 1: Total Non-Farm Payroll in the US. This time, it is different.
The Chinese government has hurt confidence by removing the Minister of Foreign Affairs and key generals from the PLA and seemingly further restraining the freedom of speech even on topics like recession and deflation[1]. Treating your political compatriots like that casts doubt on recent talk about friendliness towards entrepreneurs and makes it urgent to reignite the economy through stimulus. The global economy and markets continue to heal. The price of money has risen significantly in Europe and the Americas, still US employment growth has been much faster in recent years than after previous recessions, and recently this has occurred while inflation has continued to trend downward. The almost 160M people employed in the civilian non-farm sectors represent approximately 2% of the global population contributing about 25% of global GDP (15% in PPP terms). This again shows that economic growth as well as the pursuit of global dominance are less about the number of people involved and more about the technology and institutions[2]. Through 2023 markets have coped well with the needed monetary tightening, inflationary pressure has eased, and the growth outlook has improved, setting the stage for the end to the US earnings recession. With the return of volatility in early August, we maintain our balanced positioning while awaiting more clarity on the drivers of our position-taking in the coming weeks:
In our growth strategies, with up to 100% equities, we hold equity allocations close to neutral levels around 60%. In EDGE Sustainable Growth, these positions remain 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 average levels which, in most cases, means we have reduced our allocation from 50% to around 30%. We are maintaining significant holdings of high yield bonds in these strategies.
Across our Global Fixed Income Opportunities portfolios, we have reduced our overweight in high yield bonds by allocation 20-30% to high grade bonds. We are maintaining a short duration.
[1] FT 7th of August 2023. “Chinese economists told not to be negative as rebound falters”.
[2] Based on our reading list, we recommend the following books on these topics: “SPQR - A History of Ancient Rome” by Mary Beard, “The Return of Depression Economics” by Paul Krugman, and “Why Nations Fail” by Daron Acemoglu and James Robinson.