Cross-Asset Quarterly Outlook

September 2023*

Growing Headwinds for Buoyant Equities

  • Global growth decelerated further in recent months, but the current level of activity remains close to trend.
  • Global equities continued to outperform fixed income, while commodities were the best performing asset class since the last Outlook.
  • Current valuations favour fixed income relative to equities, while industrial metal commodities offer an attractive entry-point for longer-term demand.
  • We upgrade commodities to overweight and reduce rates to underweight. We remain overweight credit and neutral equities. Our intra-asset class allocations continue to favour higher-quality duration assets in anticipation of a peak in the Fed’s hiking cycle.

Since the last Cross-Asset Quarterly, global fixed income underperformed global equities and commodities. We continue to believe that fixed income looks attractive at current levels. However, the combination of central bank hikes, elevated inflation, and the absence of a US recession year-to-date have been medium-term headwinds for bonds. In addition, the recent optimism towards generative AI developments have also contributed to equity strength (led by IT and the US market). Commodities were the best performing asset class (led by crude oil) following a further extension of the OPEC+ cuts.

The recent global dataflow is still indicative of a relatively resilient economic environment. The Global Composite PMI fell to 50.6 in August, which is still consistent with trend-like growth and supporting equities relative to bonds. However, our asset allocation continues to maintain a neutral equity stance given our expectations for further pressure on earnings. The European growth outlook is starting to show weakness with the August Eurozone composite PMI in contractionary territory at 47.0. China’s economic activity has also disappointed this year; however, we note some recent improvement in the manufacturing sector. Finally, the US economy has been resilient, but will likely slow as past monetary policy tightening continues to work through the economy. Overall, we expect a further deceleration in economic activity over the next six to twelve months.

The key short-term risk for inflation and bonds is the recent oil price spike. OPEC+ supply cuts have helped push Brent crude prices back above $90 for the first time since 2022. Should prices continue to rise, headline inflationary pressures will likely intensify again in major developed market economies and keep central bank policy tight. Even accounting for these risks, core inflation measures remain on a disinflationary trend as activity slows, while the current level of developed bond yields appears attractive in absolute and relative terms. Indeed, the US 10y bond yield relative to the US equity earnings yield is now at a high from before the Global Financial Crisis (GFC) as shown in Chart 2. From a cross-
asset perspective, the relative valuation for equities versus bonds is unattractive, and equities will need robust earnings growth over the coming quarters to justify further outperformance relative to fixed income.

Chart 1: Asset Returns, End-May to End-Aug, %

Source: Bloomberg

Chart 2: Yields, %

Source: Bloomberg

*The publication reflects asset performance up to August 31, 2023, and macro events and data releases up to September 8, 2023, unless indicated otherwise.

The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.