Alternating market sentiment

• Optimism seems to have crept back into markets late last week, with indications that a debt ceiling deal could be within reach in the US, which pushed equities and bond yields higher. Falling jobless claims and some hawkish comments from the US Federal Reserve suggesting continued focus on curbing inflation were contributing factors to higher US Treasury yields.
  
  
• A market view that inflation will come down significantly with no recession is over-optimistic in our opinion. While it may spark some volatility around the future path of interest rates in the US if this doesn’t happen, we think the Fed will nonetheless pause its monetary policy tightening cycle going forward. Higher interest rates, via tighter lending standards and declining loan growth, are all weighing on the economy. This week, investors will closely watch May’s release of the purchasing managers’ index for further confirmation that US activity remains weak.
  
  
• The interplay of rising stocks and rising bond yields appears to have been taken as positive for market sentiment. But, when overlaid with US dollar strength and tighter credit and financing conditions, we think the mood might be excessively optimistic. We remain overweight government bonds as our view is that the combination of slower economic growth and the peak in interest rates will likely support high-quality fixed income.
  
  
• Turning East, a batch of economic data in China last week raised some concerns that the economic rebound may be losing steam. However, we think the economy has room to normalise further. With weak inflation, China can continue to support its economy. China does seem to face a lack of domestic confidence after three years of strict lockdown, but our base case has always been that this will likely come back gradually. Record-high domestic tourism data for the May holidays supports this view.
  
  
• In addition, economic normalisation through a return of consumer confidence tends to take time in many other countries and regions. This has been the case in Japan, which lifted most of its restrictions in 2022 but where the data picked up more visibly only in the first quarter of 2023 as economic growth rose above expectations. Within our equity allocation, we maintain a preference for the Asia-Pacific region including Japan. 

PORTFOLIOS AT A GLANCE

• With the company earnings season coming to an end, this week we are focusing on its impact on some of our key direct equity holdings in flagship portfolios.
  
  
• Our direct equity holdings generally reported earnings that exceeded analyst expectations, particularly within the tech sector, while our low exposure to real estate and utilities proved to be the right choice.
  
  
• At the individual stock level, heavyweights such as Apple, Microsoft and LVMH once again performed credibly. In addition, in the industrials sector Siemens and Fortive reported solid results.
    
• We previously discussed our financial sector exposure, which is biased to higher quality companies. Here, companies such as JP Morgan, Blackrock or Berkshire Hathaway also posted good quarterly results.
  
  
• The picture was more mixed in the health care sector, where we saw results above expectations for our investments for the most part, but the sector as a whole is not currently an investor favourite judging from a range of ‘technical’ and other indicators.
  
  
• This positioning should help our flagship portfolios better navigate potential market turbulence, which may emerge following the sharp rise in interest rates and increased recessionary pressures. Given the risk of heightened earnings disappointments over the next few quarters, we maintain a prudent approach to company selection, focused on larger cap companies with stronger balance sheets.

Our near-term asset-allocation strategy for flagship portfolios remains: 

• a slight underweight equity exposure and slight overweight fixed income exposure,
• a bias towards quality investments within equities, and
• holding more developed market government bonds than riskier bonds within fixed income.
  
  

Past performance is not a reliable indicator of future returns.