Maintaining a defensive positioning with an eye on the interest rate path

• Growth concerns weighed on markets during the first part of last week as data revealed a slowing in economic activity. Any hopes that US interest rates cuts may come soon were dashed by a blockbuster non-farm payroll data release, contrasting a weaker-than-expected employment report on private businesses released earlier.
  
  
• As a result, equity markets closed the week 1-2% lower across the board, with no significant outliers in developed markets other than the US, which saw a rally at the end of last week and ended somewhat higher.
  
  
• Government bond yields rose too (pushing prices down), although the market continues to believe that the US Federal Reserve (Fed) will not go ahead with the final hike it has planned before the end of the year (we expect a final rate increase).
  
  
• After a summer surge in oil prices following the announcement of supply cuts from OPEC+, oil prices fell 8% last week, highlighting that demand is slowing. The fall in oil price didn’t help emerging market equities, particularly countries exporting commodities, which underperformed their peers in developed markets. However, oil surged back at the beginning of this week as geopolitical risks came back to the forefront. The latest events in Israel don’t pose a direct and immediate threat to the oil outlook, but a deterioration of the conflict and/or its broadening to the wider region could impact oil flows.
  
  
• Manufacturing activity has picked up globally but is still weak overall, while services activity in the US continues to moderate.

• September and early October have seen equities and bonds selling off amid markets pricing an increasing likelihood of a ‘higher for longer’ rates scenario.
  
  
• This is similar to the market dynamics we saw in 2022. The difference? In 2022, rates were at zero in a growing economy with accelerating inflation. Now, they’re at 5% or more in a slowing economy with decelerating inflation.
  
  
• We believe a recession is likely in the UK, Eurozone and, with a lesser probability, the US, so we’ve kept our defensive positioning in portfolios. What this means in practice is that we hold fewer equities and more high-quality government bonds than normal.
  
  
• We maintain our conviction in high-quality government bonds and low-volatility stocks, as we expect them to provide a buffer if market volatility were to increase further.
  
  
• The main driver of returns is our longer-term strategic allocation, which is based on global diversification. Year-to-date (and over the years), this approach has performed better than those more heavily focused on European or UK domestic markets, as these have underperformed US equities.
  
  
• As with our tactical approach, our fund selection approach - balancing growth vs value styles - has been a drag on performance during the equity market rally this year, which is now reversing.
  
  
• Year-to-date, our global stock selection – quality companies with solid fundamentals – has outperformed while giving back some gains in September as equity markets sold off. Our flagship portfolios are the sum of all these parts working together and complementing each other.

• This week features US inflation and consumer sentiment data, and the minutes of the September Fed meeting. Recent communication from Fed officials has revealed little concern about the rise in government bond yields that could potentially threaten their expectations of a soft landing (inflation moderating without a recession).
  
  
• We continue to agree with the Fed that inflation will moderate throughout 2024. However, we disagree with the central bank on the prospect of a US recession. We think the US economy will fall into a mild recession as financial conditions are tight and borrowing costs high. This should exert further downward pressure on consumer spending, as shown by falling weekly retail sales data.
  
  
• In the UK, GDP growth for August is due, and the data could shed light on what the Bank of England does next. There’s been a shift in tone from central bank officials, which could mean that interest rates have already peaked in the UK, although we do not rule out the possibility of one or two interest rate increases – which we keep in our baseline scenario for now.
  
  
• Inflation data is also due in China, alongside international trade and credit growth figures. Activity seems to have picked up somewhat during the summer, but the real estate crisis is a clear headwind for Chinese growth. This is one of the reasons why we recently reduced our exposure to China and Asia-Pacific equities.
  
  
• The earnings season for the third quarter is kicking off, too, with the large US banks starting to report their results at the end of this week. Investors are likely to focus on guidance going into year-end, and on the impact of interest rate increases on lending volumes and the housing market.

Past performance is not a reliable indicator of future returns.