In January, the US economy created many more jobs than expected, highlighting the ongoing strength of labour markets despite the lagged impact of last year’s monetary tightening. Furthermore, revisions to past inflation data and higher-than-expected prices in the services sector have made the path back to central banks’ targets more uncertain. Markets raised expectations regarding the level at which interest rates will peak and also the length of time they will stay there, pushing bond yields higher across the term structure. As has often been the case recently, the sell-off in bonds was associated with a correction in equity prices.
However, despite the negative market reaction, several factors continue to support a more favourable investment environment than last year. First, the improved economic data and the expectation that China’s reopening will support global growth means that the risk of a recession in the next few quarters has diminished. An improved growth outlook means fewer headwinds for corporate profits.
In addition, it is worth remembering that monthly data are volatile and we should not place too much emphasis on a single data point. Extrapolating from one inflation report misses the broader point that underlying inflation trends remain consistent with a progressive moderation in the remainder of 2023.
This means that, in terms of portfolio allocation, a moderate overweight in equities and bonds remains warranted in our view. Within equities, the UK market lagged other developed markets in January, reflecting expectations of a recession and ongoing challenges associated with Brexit. However, most of the bad news seems now priced in, including tighter monetary policy. This justifies a reduction in the underweight in UK equities, financed with the trimming of exposures to US and Swiss equities.
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