Developed Markets Quarterly Outlook

May 2023*

Balancing Contrasting Economic Scenarios

Better economic data supported global equities despite tighter central bank policy, banking stress, and a looming US debt-ceiling standoff. A range of scenarios are possible in this year’s second half, but we maintain our conviction in a desynchronised cycle favouring the Asia region this year. Positive surprises in the US and European earnings are unlikely to be sustained.

Global equities (measured by the ACWI World Index) remained buoyant in recent months despite renewed fears of recession. Since the last Developed Market Quarterly Outlook, the market has digested three US bank failures representing over $500 billion in assets. In Europe, Credit Suisse merged with its Swiss rival UBS. The ongoing bank stress in developed markets (DM) raises concerns that credit conditions will tighten further. In combination with tight central bank policy, a recession is becoming more likely later this year.

We see a high risk of a material slowdown and a low risk of a ‘soft landing’ in 2H23, but we are cautious towards positioning heavily in a defensive direction. Despite growing expectations for a material global growth slowdown, forecasters have underestimated the resilience of the data this year. The global PMI composite activity index has risen for five consecutive months to an expansionary 54 level. Strength was broad-based across regions, with growth momentum from the US, Europe, and China. The economic surprises also chime with positive surprises in earnings growth. In Q1, US and European companies are tracking EPS beats above their respective historical averages. In addition, net earnings revisions (i.e., number of analyst upgrades minus downgrades) turned positive for the global index for the first time since February 2022. We do not interpret recent growth momentum as a reliable signal to be positive towards cyclical stocks, but the data flow warrants restraint against an overly bearish stance.

The policy backdrop will likely remain restrictive in DM economies until a material softening in demand brings inflation closer to target. The lagged impact from the Fed and ECB policy tightening should weigh on DM earnings this year, even if we are closer to (or past) a pause. In contrast, the market may underestimate the risk of more stimulus in China. Indeed, recent data flow has raised concerns that China’s recovery is starting to fizzle out. China’s manufacturing PMI moved back into contractionary territory in April, while April import data also recorded an unexpected contraction. Given policymakers’ commitment to “around 5%” growth, any growth disappointment raises the risks of more policy support, reinforcing our expectations for a more desynchronised growth cycle this year.

Market Strategy: Our current country allocation seeks to avoid excessive exposure to either pro-cyclical or defensive countries given the contrast between data resilience and more restrictive policy in DM economies. In addition, we continue to expect a more desynchronised global cycle favouring equities more closely linked to China’s economic cycle. Since our last Quarterly Outlook, we have made no changes to our allocation:

  • Maintain the EM overweight. A desynchronised global cycle and a weaker dollar favour the MSCI EM Index. Furthermore, potential growth in AI is an upside risk for the index’s significant semiconductor exposure.
  • Maintain the UK overweight. Attractive value and a higher defensive weighting leave the index well placed to benefit from a global growth slowdown.
  • Maintain the Canada and Australia overweight positions. Both indices have suffered from negative sentiment towards commodities and bank stocks. We expect these trends to fade; both country indices offer attractive value.
  • Maintain the Eurozone underweight. The index has outperformed following better-than-expected European growth and positive sentiment towards Cyclical and Value stocks. A hawkish ECB and a growth deceleration are downside risks for the historically cyclical index.
  • Switzerland remains underweight given that it continues to screen rich on our valuation measures.

Global Equity Allocation Breakdown

  Chg -2 -1 0 +1 +2
US –        
Canada –        
Eurozone –        
Switzerland –        
UK –        
Japan –        
Australia –        
EM –        

International Equity Allocation Breakdown

  Chg -2 -1 0 +1 +2
Canada –        
Eurozone –        
Switzerland –        
UK –        
Japan –        
Australia –        
EM –        

*This publication reflects asset performance up to 28 April 2023, and macro events and data releases up to 12 May, 2023, unless indicated otherwise.

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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.