In 2022, we outlined our ‘everything breaks’ portfolio, which meant constantly overweighting cash above all else. We have stuck with that into 2023, and it has held us in good stead. Indeed, after the Silicon Valley Bank (SVB) failure, there was a dash for cash. This reminds us that at times of market crisis, cash is king. And remarkably, even cash at an unsafe bank like SVB was ultimately protected by the US government. Our bias though is to park cash in T-Bills.
Markets are still uncertain around whether the US bank support measures are enough to stabilise the US banking sector. We think they should be, but bank runs are driven as much by psychology as economics. Therefore, we need to see how the dust settles in the coming weeks. But this does mean there is a new theme to be added to our list of dominant drivers for markets in 2023:
- US and global banking risks. Weak banks to remain under pressure. If this morphs into a full bank crisis, then all bets are off and we could see large asset market selloffs. Our bias is that we will not see a 2008 style bank crisis, but the volatility will hit risk markets.
- Investors expect the end of Fed hiking cycle soon. The bank volatility has brought this theme back into play. Inflation remains high, so we still think the Fed will march on and hike rates.
- Big bounce in China growth on reopening. Data is starting to show growth accelerating. Investors are unsure how strong the bounce will be, so there remains opportunities to position for China growth.
- Broadening inflationary pressures in Europe. This has allowed the ECB to continue to hike.
- The Bank of Japan (BoJ) could adjust its yield curve control (YCC) bands. The BoJ has a new governor (Ueda) who may eventually exit YCC.
Investors seem convinced the Fed is one hike away from ending its hiking cycle. Some think the latest US banking woes signal that the Fed has broken something and so its job is done.
But we are less sure.
Inflation is still high, unlike the last banking crisis in 2008, so pausing hikes is a challenge. Moreover, the most effective way to mitigate bank risks would be to nationalise bank risks as much as possible. Indeed, the recent SVB rescue package from the US government (effectively insuring all deposits and the Fed taking on the mark-to-market losses of banks through its new lending facility) is a form of nationalisation of risks.
Given the large bond rally, the market appears to have priced a very dovish Fed. We disagree so like to stay underweight bonds, especially shorter tenors (e.g., 2-year). But the bank issues show that risk markets are vulnerable, so we like to return to being underweight equities.
Meanwhile, we turn neutral on commodities (from overweight) as heightening market volatility could impede a commodity rally. Although it has been trading well given the news, we stay neutral crypto as it remains a risk asset.
Finally, we still favour an overweight in cash – our favourite asset in a world transitioning from low rates to high rates.
What Is the Consensus on Asset Allocation?
As for consensus, we find a bias to be overweight bonds, underweight US equities, overweight EM equities and neutral on credit. Compared to our last report, the main changes are that Blackrock have turned bullish EM equities from neutral and State Street have turned bearish US equities from neutral. Of course, not all firms have updated their views since the US bank failures, so these views may shift in the coming weeks.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
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