Broadening State Support, Supportive of Risk Assets
– Improved Market Outlook due to safety nets and more measured monetary policy tightening.
– Geopolitical narrative expected to shift towards peace and reconciliation ahead of elections US and EU.
– Developed market economies, US, EU, UK, and Japan, may experience a growth deceleration as tighter monetary policy in place now for several quarters begins to impact.
– We are tilting portfolios from defensive towards mild risk-on. Public market positioning:
- Cash – Reduce overweight.
- Fixed Income – No change; remain underweight. Within Fixed Income we remain overweight select emerging market debt.
- Equities – Move to overweight. Within Equities we move developed market equity to overweight, adjust our sector and style allocation and remain overweight select emerging markets.
- Hedge Funds – No change; remain underweight.
- Gold – Reduce overweight.
- Commodities – No change; remain overweight.
- Volatility – Reduce overweight.
The market outlook has improved due to rapid action across regions to address banking and financial market stability concerns. Government officials understand the need to ensure that the financial system remains sound and fully operational. As such, we expect, central banks will adjust policy in a more measured manner. In addition, Chinese President Xi and his party have tried to introduce the idea of peace and dialogue into the narrative regarding the war in Ukraine. Ahead of elections in the US and EU Parliament, China’s initiative, although lacking details, may nevertheless help move voters and some politicians to favor dialogue and peace over war and further destruction.
“After all, there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the people’s confidence.” President Franklin D. Roosevelt March 12, 1933
The task of managing the economy is tremendously complex, but the authorities know what is at risk. Confidence in the system needs to be fortified ASAP. The Fed, FDIC, FASB (GAAP), and Treasury, all need to work together to find ways to reduce risk urgently. Banks serve a critical purpose and thus should be allowed to take on only limited risks. A sector that is critically important for the national economic security of a country needs to be more heavily regulated. As for the Fed and other policy arms, the silo approach to managing economies needs to make way for an intensely collaborative approach to effectively managing a complex economy in our complex world.
For now, we expect the official response to the banking mini crisis in the US and Europe to be adequate and prevent further erosion of confidence. If needed, authorities will respond more aggressively, comprehensively to stem any further deterioration of confidence due to concerns about the banking sector. Investor confidence, however, is fickle and can change quickly. Thus, we will remain vigilant for any signs of stress while stepping back into an overweight equity allocation.
Recent geopolitical developments again provide evidence of continued geopolitical fragmentation. China and US continue to create two distinct camps. Meanwhile, some nations are left to “thread the needle” and try to balance relations with these two superpowers. On the other hand, several constructive developments suggest a possible improvement of the geopolitical narrative. Events include reestablishing diplomatic ties between Saudi Arabia and Iran and furthering relations between Russia and China after China put forward a peace plan for the war in Ukraine. Meanwhile, NATO continues to favor war over dialogue and has not taken the Chinese president’s political settlement of the Ukraine crisis plan seriously put forward on February 24.
The global economic outlook has been somewhat resilient. PMI data show signs of some recovery across economies, but markets are more concerned about financial market stability. Given the recent market turbulence, data is taking a back seat to stability concerns. We believe authorities will do what is necessary to maintain stability; thus, concerns are overdone. However, lingering worries about financial market stability will further slow or delay monetary policy tightening. Other economic activity data are mixed, showing signs of weakness in business and consumer spending. Furthermore, bank lending standards in both US and EU have tightened while demand for loans and credit has dropped, see chart below for US.
Still, at the same time, additional data offer signs of either stabilization or pickup in economic activity. Composite PMI data for many economies are showing signs of some stabilization. For significant economies US, EU, and China, government-led programs and initiatives are helping to create activity across economies. In the US, combining the Inflation Reduction Act of 2022, The CHIPS Act of 2021, and the Infrastructure Bill of 2021 collectively make ongoing activity across the industry. In the EU, the Next Generation, Horizon Europe, Invest EU, European Green Deal, and Digital Europe Programme, are examples of EU programs to stimulate growth and make the EU more competitive and greener. In addition, the government has a long list of programs and plans to reinvigorate growth in key strategic sectors in China. In the GCC, the energy price windfall from the past few years (April 2020 trough to August 2022 peak, +60%) has accelerated diversification plans and programs.
While there are some downside risks stemming from financial market stability concerns, we expect authorities to act aggressively and protect the financial Infrastructure. Thus, we believe such risks to be limited in severity and duration. Meanwhile, inflation remains a problem. Therefore, central banks must continue with their effort to contain and bring inflation to a lower level remains in place. However, unless there is heavy margin compression, a slowing economy is not necessarily harmful to markets, given it suggests major central banks may be near the end of this tightening cycle. Given our view that central banks will focus more on financial market stability than inflation, further rate hikes will be slow and small, supportive of both financial market stability and select risk-on assets.
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