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November 2023

Asset Allocation Outlook

  • High US growth unsustainable, Eurozone economy still weak
  • Inflation news positive but too soon for cuts to interest rates
  • Corporate results considerably stronger in the US than in Europe

October marked the third consecutive monthly decline in global stock markets. Decisive factors were the outbreak of Middle East conflict, mixed third-quarter earnings results, and ongoing worries about sustained high US interest rates. The MSCI All Country World Index decreased by 3% in October, bringing its 2023 total return down to 6.7%. The yield on the 10-year US Treasury reached 5% for the first time since 2007, as worries about excessive government borrowing and robust economic data reduced expectations of swift interest rate cuts by the Fed in 2024. Higher yields weighed on the S&P 500, which lost 2.1% and, at certain points in the month, was down more than 10% from its peak in late July. The Eurozone market experienced a 3.3% decline, resulting in a year-to-date return of 6.6%. This drop was prompted by additional indications of economic fragility within the region. The MSCI China Index could not escape the trend and closed 4.2% lower despite the government implementing more assertive stimulus measures.

The focal point of October was the tragic events in the Middle East that prompted investors to seek safety in traditional safe-haven assets, notably gold, which saw a 7.3% increase over the month. While oil prices also rallied amid concerns that an escalation into a wider regional conflict could disrupt oil supply, they ended the month 3.1% lower as market concerns about the global economy's health and implications for oil demand came to the forefront. If the conflict were to escalate, the World Bank warned that the global economy would face a dual energy shock for the first time in decades – not just from the war in Ukraine but also from the Middle East.

Market concerns about global economic growth were emphasized when the Eurozone reported a 0.1% decline in its gross domestic product for the third quarter as consumers reined in spending. The Eurozone economy continues to face substantial challenges, as indicated by a 35-month low in the flash composite PMI. Manufacturing has been struggling for sixteen months and services for three, and both PMI headline figures have recently worsened. A "mild recession" during the latter half of this year looks pretty likely. Labour market indicators remain historically robust, but job vacancies and wage growth are declining. The ECB is signalling its comfort with interest rates at 4%, giving more significance to the unfavourable growth outlook. Ultimately, the soft inflation prints (October: 2.9%, core: 4,2%) reinforce our view that the ECB is likely done with its hiking cycle.

US Treasuries deviated from their typical role as a safe haven, with government bond markets primarily influenced by the surprising strengths of economic indicators in the United States. The US Q3 GDP release delivered a very positive signal about the US economy. Economic growth accelerated from 2.1% to 4.9% (q/q) annually. A significant acceleration in consumption growth accounted for 2.7% of the overall increase. US consumers are using up their excess savings less rapidly than previously thought. And labour demand remains strong. Based on the September data, employment growth increased from 150.000 to 266.000. As a result, investors saw increased potential for the Fed to slow the economy through further rate hikes. The Bloomberg US Treasury Index recorded a negative return of 1.2%, contributing to a total loss of 2.7% for 2023.

The correction in equities has occurred despite encouraging trends in corporate earnings, particularly in the US. The earnings downturn in the United States is behind us. As the third-quarter earnings season reaches its final stages, approximately 75% of the US companies exceeded expectations. Earnings per share are expected to increase by 4% for the third quarter. Growth can mainly be attributed to robust consumer spending, the revival of the goods sector and solid numbers from some technology megacaps. It is worth noting that analyst's earnings expectations for the fourth quarter have been adjusted downward due to some exceptional factors (e.g., United Automobile Workers strike). However, consensus earnings growth estimates of +6.7% for European and +11.7% for US corporates over the next 12 months look pretty optimistic, especially when considering slower economic growth, decreasing inflation, and skyrocketing refinancing costs.

While we continue to see headwinds for stocks, conditions for a short-term rebound are in place. During the FOMC meeting on November 1st, the Federal Reserve underlined that tighter financial conditions would weigh on the economy, reinforcing remarks from top officials that higher Treasury yields are doing their work in slowing economic activity and, ultimately, inflation. These comments were perceived as dovish and sparked a broad rally in stocks as market expectations for further rate hikes collapsed. Furthermore, the latest ISM survey and job report delivered what investors hoped for. The ISM Manufacturing survey for October pointed to slowing factory activity; it fell to 46.7, the weakest reading since July. US labour market data showed productivity advancing by the most in three years, easing concerns of wage-driven inflation. Meanwhile, the 150.000 increase in payroll employment fell below expectations and marked a slowdown from the 297.00 increase in September. The unemployment rate unexpectedly rose to 3.9%.

Much economic data remains resilient. But the latest data supports our view that growth will cool over the coming months as previous rate hikes work through the system. We retain our preference for the higher-quality segment of fixed income. However, considering that employment conditions are still tight, it is likely too early to bet on an imminent pivot to a policy-easing stance and a significant decline in yields. As a result, there is little room for yields to continue to act as a supportive factor for stocks. While stocks may rise further into the year-end, we retain our outlook for a slightly longer term and remain underweight.

Please find attached our last Asset Allocation Update for November.

Asset Allocation Outlook November 2023

Jan-Willem Verhulst

Jan-Willem Verhulst


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