Mosaique Views: Markets in perspective

november / december 2022

Markets are still grappling with interest rate and geopolitical risk

 

Our thoughts remain with those hurt by the dreadful conflict still raging, which puts our economic concerns firmly into perspective.

Recently, those concerns have nonetheless become a little more pressing again. Inflation and interest rates still have yet to peak, and growth is still slowing.

The severity of the downturn remains unclear. Europe is most at risk from energy costs and potential supply shortfalls this winter. As yet, however, despite widespread expectations of an imminent and sharp recession, forward-looking data continue to point to a gradual slowdown, and governments are acting further to protect poorer households from the worst of the energy squeeze – which may be peaking: gas prices have softened at last.

Elsewhere, the important US economy is less exposed, and has some momentum (despite its poor GDP showing in the first half). China’s economy faces ongoing structural headwinds, and a strict zero-covid policy, but it has the rare luxury of a low inflation rate, allowing its authorities to follow a more lenient monetary policy.

So, talk of global “stagflation” still looks premature to us. That said, the geopolitical climate remains troubling, and not just on account of the ongoing trauma in Ukraine. The West has been reminded that China’s claim on Taiwan is not negotiable (though that does not mean that it is imminently actionable either).

We had already reduced our equity weightings in the New Year as it became clear that interest rates might rise faster than expected. We reduced them further on news of the invasion. In each case we chose to keep the funds in liquid form – this might look unusual at a time of inflation, but in the short term cash is more stable even in real terms than are securities, and it would allow us to capitalize on opportunities as they arose.

Our equity holdings returned to neutral only. Valuations have now fallen significantly and we still see corporate profitability staying healthy, but interest rate and earnings risk remain elevated, and we remain neutral.

We have however used some of the extra liquidity to add to our bond holdings, reducing our underweight positions in US and European portfolios. Bond valuations arguably improved by more than equities’ as the increase in yields accelerated, and we have been tactically underweight bonds since Mosaique’s launch. We have now moved a step further towards neutrality in US portfolios by closing our preference for shorter-duration bonds.

And within equities, we have now decided to close our long-standing overweight in emerging Asia, using the funds to close our underweight in Switzerland. Reducing positions in China after its market has already fallen sharply – and with its economy still outperforming, as noted – is frustrating, but there is no obvious catalyst visible currently.

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