Key Points:

  • A global recession remains our base case, although we now concede it is more likely H1 next year. The US has been more resilient than we had anticipated and is propping up the global economy making the global economy vulnerable to a US downturn.

 

  • The sell-off in global bonds over the past month has been rapid, led by a widening term premium rather than increasing short-rate expectations. This is a concern for us because it means that the war on inflation is far from over. The free kick central banks have received with better-than-expected inflation readings could soon be over.  Inflation remains well above central bank targets and more resilient growth becomes a target to be shot rather than a sign that a recession will be avoided.  We still think we are partially through the adjustment in equities.  During a recession, equities always sell off, Government bonds always rally and credit spreads always widen.

 

  • We retain our underweight to Growth assets and significant overweight to Cash. We reduce by 1pt our overweight to global fixed income and global infrastructure.  We maintain our underweight in US high-yield credit and reduce our underweight in investment-grade credit.  We also reduce our underweights in global property and infrastructure, where most of the impact from last year’s increase in bond yields will have been reflected in valuations and the assets offer good inflation protection.

 

  • Japan remains our top equity market pick but is now followed by Europe. Australia has fallen down the pecking order to be at the bottom with the US because of its deteriorating earnings outlook. US valuations are stretched on all metrics even after upgrades in August.
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