June was a brutal month for markets. Equities were down 9%, commodities fell 8%, corporate bonds fell between 3% and 7%, EM bonds dropped 5%, and crypto plunged 40% to 50%. Government bonds did the least bad, with only a 1% decline. It is unusual for every asset to decline in a month, but June was that month. Worryingly, July has started on a weak footing too.
What caused this? Certainly, a surprise Fed hike of 75 basis points, which raised policy rates to 1.75%, harmed risk markets. Then there was a steady stream of weak activity data, which saw recession fears increase dramatically. Our recession model had been citing this risk for several months, and broader markets appear to have caught up to the view.
In terms of our asset allocation view, our constant refrain to seek refuge in cash has turned out to be prescient. It may have only delivered a tiny positive return in June, but it escaped the large losses seen elsewhere. As we have written before, markets are undergoing a regime change with central banks raising policy rates. This means more instability, more risk of losses, and more uncertainty. In such an environment, preservation of capital is essential so overweighting cash is a prudent strategy. We stick to that view.
As for other markets, we had reduced our commodity overweight last month, and we move to neutral now (Chart 1). We still think both energy and soft commodities have structural supply issues, but market volatility and recession fears could limit gains in the near term.
We have been heavily underweight government bonds. But given the increasing spectre of a recession, we think it makes sense to reduce the size of the underweight. We still think the market is underpricing the scale of Fed hikes, so we like to be underweight bonds with shorter tenors (say up to five years).
On equities, we like to stay underweight. Most of the equity weakness has been due to a de-rating – that is, valuations (price-earnings ratios) falling. But earnings forecasts have yet to be revised down. We think the macro picture is such that earnings will have to be downgraded. When this happens, equities could see further weakness. And on crypto, we stay neutral – it remains a risk market and will likely face downside risks.
Finally, in terms of equity sectors, here are our favourite views:
- Within US, we like to be overweight financials, homebuilders, large cap value, reopening trades, semi-conductors, traditional infrastructure and underweight large cap growth, consumer discretionary, materials and technology.
- Within Europe, we like to be overweight financials and renewables.
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.