Chris Leyland, True Potential Director Of Investment Strategy, looks back on the key themes around the True Potential Portfolios over the past month.
As part of our commitment to transparency, we always share the rationale behind the decisions we make when managing the True Potential Portfolios.
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Month to date, equity markets have fallen -4.0% in GBP terms. Fixed income yields have risen with 10-year US Treasuries now yielding 3.0%, up from 2.8%.
Volatility has been evident across asset markets, with bond markets experiencing material price moves. Volatility is anticipated to remain elevated in the near term. This environment is proving challenging for traditional sources of diversification.
Within this backdrop there are pockets of opportunity. Our exposure to alternative assets has provided some offset.
Our active managers have also been moving to exploit opportunities identified in China and China related assets (further detail below).
The True Potential Portfolios have benefitted from exposure to value as an investment style within equities and through the defensive tilts enacted by our appointed fund managers.
True Potential Portfolio View
Looking ahead, we remain cautious, conscious of the following: –
- Economic growth forecasts have deteriorated
- Inflation levels are high, proving to be sticky
- Leading to an uncertain interest rate environment and headwind to corporate earnings growth expectations
Our base case is not for recession this year, probabilities have increased with a higher likelihood of a more challenging economic environment next year.
Our cautious view near-term needs to be qualified. There are areas of strong support, such as:
- Full employment with labour conditions remaining tight.
- Consumer demand, though off its peak, remains robust.
- Strong reported profits and generally healthy corporate balance sheets.
Positioning
Since the start of the year, equity weightings have been trimmed with reductions in US and European equities. UK equities have been increased. Fixed income allocations are higher, particularly sovereign, where yields have moved higher, providing a more compelling investment case.
Alternative weightings have increased as we continue to access opportunities with both a differentiated return profile and low correlation to traditional assets.
To provide additional context to the points noted above:
We are identifying selective opportunities within fixed income.
Higher yields and defensive properties of sovereign bonds are encouraging a number of managers to increase their allocations. Duration has been increased, but managers are selective in doing so given elevated volatility.
Inflation in the US is expected to peak in the near term.
Most recent datapoints globally have highlighted that inflation is elevated, with only modest signs of easing. In the US, inflation is expected to peak in the second half (later than expected earlier in 2022) and the UK and Europe to peak towards the end of the year, into next. However, we are not anticipating a sharp roll off post peak, our view is inflation will remain sticky.
We believe central banks will continue to raise interest rates and reduce bond purchases to reduce inflation, we have seen an acceleration of this through the month from major Central banks. However, they face a challenge of doing so with economic growth slowing.
Economic growth is moderating at a faster pace than anticipated earlier in the year.
The rate of economic growth is decelerating; however, there are regional nuances. Europe and the UK face greater headwinds such as higher imported energy costs than the US, which risks curtailing demand.
Earnings have proven robust but cracks are appearing.
Despite the headwinds, revenue and earnings growth in the first half of the year has been positive, a reflection of the strength in consumer demand. Analysts are anticipating earnings growth of 10.4% for 2022 in the US, however, we are anticipating these expectations will moderate given the current headwinds.
Value is still the preferred equity style within the Portfolios.
Since the start of the year, there has been a huge disparity in both sector and style performance within equity markets. Value focussed global equities are down -12% year-to-date compared to -28% for growth focussed global equities, more sensitive to higher rates.
Chinese assets and assets related to China are attractive and managers are increasing exposure here.
At the end of May, China announced 33 measures including tax relief, fee reductions, and subsidies to stimulate the economy. China’s zero Covid policy continues to act as a drag on economic growth although there are signs that lockdowns are starting to lift. As the zero Covid policy moderates, questions are being asked of whether this will be inflationary. On the one hand, as China reopens, demand for commodities will increase leading to inflationary pressures, whilst on the other supply chains will improve proving deflationary.
Within the True Potential Portfolios, China and China-related assets have been added to or are actively being discussed as opportunities. Examples include tactical additions to China A and H shares and increases to Asia-Pacific and Emerging Market equities.
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