The tug of war between rising real yields and slowing earnings growth remains a feature of US equity markets, while the knock-on effects of the war in Ukraine hang over European stocks and Covid lockdown concerns cloud the prospects for Chinese equities.
In the US, we expect an inflation-busting Federal Reserve to raise interest rates to a level where growth will slow notably, if not – and more likely – contracts. Should US company earnings, however, remain encouraging, and the market’s policy rate expectations stabilise, equities could recover, just as they did in the first quarter. In our allocation, we are neutral on US equities.
On European equities, we are now underweight since we see significant downside potential for earnings amid continued pressure on both growth and inflation from the Ukraine conflict and Chinese supply chain issues. In addition, we expect an inflation-focused ECB to not shy away from policy tightening even as growth weakens. We would add to our short should markets rally.
We have added a short position in Japanese government bonds to underweights in US and European sovereigns, taking the view that a behind-the-curve Bank of Japan will act to deal with rising inflation, benefiting a weaker yen. We think it unlikely that 10-year JGB yields would move much lower from here. We have upgraded commodities to ‘favour’. Market dynamics/timing indicators and a window of opportunity have added to sound fundamentals such as deep demand-supply imbalances and heightened geopolitical risk.
These are highlights from our asset allocation monthly for May. Download the pdf