Portfolio Perspectives, September 2024

Fears of a US recession appear unfounded

It has been anything but dull in equity markets since our last publication of Portfolio Perspectives in July. The market has gyrated sharply on more than one occasion since then and one could come up with many different reasons for the volatility for instance AI monetisation fears, the unwinding of the Yen carry trade or even the US Presidency. But these individual reasons only mask what the market is now really worried about, and that is fear of a US recession. Inflation is increasingly being seen as having been tamed. Even higher-than-expected US core inflation readings for August weren’t enough to upset the disinflationary consensus when the data was released earlier this month. 

Brian Flavin,
Senior Equity Research Analyst

Strong performance from sovereign bonds as rate cut expectations come to the fore

Since the last edition of the Portfolio Perspectives in July, markets have been experiencing a tumultuous time navigating unexpected outcomes from data releases such as the weak US jobs report in August, the acute volatility in Japanese markets and differing commentary surrounding the timing and pace of the US Fed’s rate cuts.

The Fed has been watching the labour market very closely, and to much relief, the jobs report from the US economy in September showed payrolls rebounding. This in turn helped to reduce investor concerns about the economic picture. Coinciding with this more positive data was commentary from Fed officials cementing investor conviction that rate cuts were almost certainly on the table for the September meeting. This possibility was realised when the Fed cut rates by 50bps at their monetary policy meeting on Wednesday, 18 September. Across the Atlantic, inflation has continued moving downward toward the European Central Bank (ECB) 2% target; the ECB again lowered rates by 25bps to a 3.5% policy rate last week.

But what has all this investor and central bank activity meant for fixed income markets? With US investors pricing in and subsequently receiving an aggressive 50bp rate cut, sovereign bonds have been the stronger performers in recent weeks. The strength of US Treasuries has reverberated across the Atlantic with Government bonds in the euro area also outperforming their corporate counterparts.

With all of this in mind, the Fixed Income Strategy team has incrementally added duration across the portfolios, which are now closer in line with the Euro Aggregate benchmark duration profile but ultimately still remaining underweight on a relative basis. Our preference to euro area fixed income remains, where volatility from swings in rate cut expectations appear to be more controlled.

Moyah Flanagan,
Fixed Income Strategist

Portfolio positioning: a steady course through much volatility

There have been no major portfolio changes since our last update. July and August saw some dramatic market volatility but, in the end, there was little net movement in equities. The euro strengthened by about 3% over July and August, which had a negative impact on portfolio valuations due to the typically significant levels of US and other foreign equity holdings. As the dollar and other foreign currencies fall, the euro value of foreign currency assets of course falls, all else equal. Between the modest net rise of the equity market (in local currency terms) and the rise of the euro, the total return on the All-World equity index was broadly flat. Portfolios still mostly saw some gains as bonds rallied through the equity dip.

After a very dull first half, bonds experienced strong gains with the Euro Aggregate index returning nearly 2.5% over the past two months. The big driver of the bond rally was the fall in interest rate expectations for major central banks. As longer-dated bond prices are most sensitive to interest rates, these assets outperformed and provided support for portfolio performance. Mid-duration bonds lagged behind but still showed a gain of near 2%, but outperformed short-maturity exposures. Having lagged behind corporate bonds for the year-to-date, government bonds fared very slightly better in the past two months. Year-to-date, mid-dated corporate bonds, where our exposures remain most concentrated, have been the best performing segment of the euro investment grade bond market. 

Within equity markets, our defensive positioning remains intact and produced mixed results over the volatility and subsequent recovery of the past two months.  Healthcare and Industrials, our two largest overweight positions in equity portfolios, were among the strongest performers. Healthcare was only bettered by the interest-rate sensitive Utilities sector which reacted strongly positively to the fall in bond yields. Our modest underweight position in Utilities was a drag, but compensated by our underweight exposure to Energy which has been the weakest global sector. The more notable underweight in Financials was a drag on equity portfolio performance, as it also responded strongly to expectations of lower refinancing rates.

Overall, we remain positioned for cautious optimism on equities, with portfolios holding neutral to modestly underweight exposure with a defensive sector bias and a focus on structural growth themes.  

Joe Prendergast,
Head of Investment Strategy