Investment is a journey, we believe an active multi-asset approach to investment provides the optimal approach to accessing global investment opportunities and navigating challenges with the support of leading investment specialists.
As we look ahead, we see opportunities, as headwinds, such as higher inflation, faced through 2022 are receding. Strong labour markets are supporting consumer spending, maintaining corporate profitability and mitigating some headwinds from tightening credit conditions.
From an asset class perspective, the opportunity set in the bond markets, primarily government bonds, where yields have risen to attractive levels making them a vital source for both income and for diversification within multi-asset portfolios.
We provide additional insight into each of these topics along with key examples of the decisions taken by our fund managers and the True Potential Portfolio management team to position our client portfolios optimally.
Financial conditions are tightening.
Recent data has illustrated the long and variable lags of tighter monetary policy are taking effect. Demand is slowing. The availability of credit to both consumers and businesses is tighter. Bank Officers in the US are not only tightening credit terms for small businesses but their willingness to make loans is curtailed by the stress impacting US regional banks. This we believe will reduce credit availability in the economy leading to weaker economic activity later this year.
Inflation.
An environment of headline disinflation is underway. The main drivers are lower energy prices and normalised supply chains. The former is an important component for regions such as Europe where we have seen a material easing of natural gas prices (340 EUR/MwH August 2022 to under 26 EUR currently). In the UK, we anticipate CPI to peak in the second quarter and base effects lead to a sharp decline in inflation through the second half of 2023.
Core inflation remains high and still rising in parts of the developed world as consumer demand, shelter, wages and service elements within the inflation basket remaining resilient. For context, US annual headline CPI was 4.9% in April, whilst Core at 5.5% is elevated, with a similar dynamic observable in Europe. Barring any significant economic slowdown from ongoing US regional bank stress we anticipate US core inflation will be above the Federal Reserve 2% target through 2023.
Recessionary risks.
Strong labour markets and robust services demand in the US have reduced the odds of a US recession in 2023. However, lagged effect of monetary tightening and recent events in US regional banking sector has the potential to edge up this probability later in the year or perhaps into the first quarter of 2024.
The outlook for 2024 corporate earnings is uncertain, linked to the evolving economic backdrop. European and UK earnings remains supported by a material easing of natural gas prices. The first quarter earnings season in the US has been stronger than expected. With 85% of US companies reported, nearly 80% of companies have beaten market earning expectations. Companies have been able to increase profit margins as they retain pricing power and benefit from the recent falls in input prices. Nonetheless, US corporate earnings for the full year 2023 have trended lower and are projected to increase only 1% from 2022.
Portfolio commentary.
Valuation levels within both credit and equity markets have increased from last year, opportunities continue to be identified by many of our active managers.
We’ve been building exposure within the True Potential Portfolios to equities, selectively. Historically a subset of the equity market including larger cap quality US companies and defensive sectors have done better in periods of slowing economic growth. As an example, equity weightings have continued to increase this year within our Balanced portfolio.
Going forward, we believe style diversification will be crucial; with that in mind, we have been recently adding to thematic equities, particularly in the US, which provide more defensive properties as we move through the year. Within fixed income, exposure to government bonds has actively increased. The Balanced portfolio has increased exposure to government bonds from 12.2% at the start of the year to 14.9%. Higher yields mean that investors are now getting paid to hold bonds and at the same time benefit from the diversification they bring to multi-asset portfolios.
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