Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett reflects on why markets may have remained in relatively tight ranges in recent weeks, while Adrian Owens outlines his expectations for markets over the near- and medium-term, as well as where he sees opportunities going forward.

17 May 2023

David Dowsett, Global Head of Investments

Directionally markets remain in relatively tight ranges as they have done since the banking issues in March. There are a lot of issues which remain unresolved such as the likelihood of an imminent US recession, the easing of inflation and end of central bank tightening, the debt ceiling debate and the pace of recovery in China. The market is discussing these issues but there is not enough new material information at the moment to draw a strong view and dominate market direction.

The Turkish election took place over the weekend and Recep Tayyip Erdogan is the clear favourite ahead of the second round which is negative for Turkish assets. Markets do not believe in his economic policies and so reacted poorly. The percentage of the emerging markets indices now represented by Turkey has diminished dramatically. The chances of a turnaround in the Turkish story seems to have been negated by this result.

While there are no big economic releases from the major economies this week, we will be keeping an eye on:

1. The debt ceiling: President Biden and Speaker of the House of Representatives McCarthy are resuming discussions this week. The smoke signals over the weekend have been more positive. Time is ticking down and there will likely be a couple of twists and turns but the latest information has been a little more positive.
2. The G7 meeting in Hiroshima: There are a lot of geopolitical uncertainties, particularly in an Asian context and so it will be interesting to see what emerges from this.
3. Earnings: Walmart and Home Depot will release their earnings numbers this week. These act as important signals for the pace of consumption growth within the US, which is clearly one of the main uncertainties at the moment. Alibaba, Tencent and Baidu will also release earnings which will give us more evidence about the pace of the Chinese recovery.

Adrian Owens, Investment Director, Global rates and currencies

I believe we are currently at an interesting point in the markets, both in the near and medium term. Beginning with the medium term, after a prolonged period of excess liquidity, central banks have rapidly withdrawn that liquidity. This can create problems. We must also be aware that we are operating against the backdrop of a significant increase in debt, with debt levels having ballooned during Covid. Indeed, I believe we are approaching levels which are becoming unsustainable. Interest that the US now pays on its debt, made worse by rising rates, now comfortably exceeds its spending on the military. As debt levels continue to rise, principally because of demographics, this will be an ongoing issue for markets. It also has implications for inflation over the medium term.

Risk aversion among investors remains very low at present, despite some of the global issues that we are dealing with in the background, nearly all of which point to lower growth for a given level of inflation. These include climate change; demographic change, in particular the situation in China where there are fewer people joining the working age population every year; geopolitical risks, which should not be dismissed and are encouraging the move towards more onshoring, a trend which has picked up post Covid; as well as the war in Ukraine. It is important to keep all these issues in mind as the backdrop to investing today.

The focus in the markets in the near term is what the Federal Reserve (Fed) is doing, what is happening to near-term inflation and the big debate is whether we are reaching a point of easing as inflation is beginning to roll over. Very broadly, we believe there are signs of that playing out given the amount of tightening we have seen. But in terms investment opportunities today, we think they are more nuanced than what we have seen in recent years. Two years ago, we were focused on the likely pick-up in inflation and last year the broad focus was on central banks tightening policy. The positive side is that the opportunity set remains attractive as central banks remain active and market dislocations remain. Central banks are often acting quite differently and two extremes, in my view, are the UK and Brazil. Very early on, Brazil was hiking rates aggressively, taking rates from around 2% to just below 14%. In contrast, the Bank of England was very reluctant to raise rates and almost every time it did, it warned that it may be close to the end; that has created opportunity. We continue to see a number of opportunities in the markets for inter-country plays.

Second, because inflation and interest rates are a strong focus for investors, not surprisingly, relative real interest rates have become important drivers of currency. Therefore, having a good handle on rates and inflation gives investors an edge when investing in currency markets.

On a bigger picture view, now that we are entering a period of quantitative tightening and now that policy is beginning to change in Japan, and given the demand-supply dynamics from all of the debt that is being issued, we believe this all points towards higher-term premia which means a higher level of longer-term rates than we have perhaps been used to. We also recognise that there is more inflation uncertainty and there should be a risk premia embedded for that. We think this will remain in focus over the next 12 months and we are able to position for this through curve steepening trades.

In the case of the US, we believe the market has become over excited about pricing in rate cuts for later this year. We have positioned the strategy short US rates versus the Euro area and UK. Throughout last year, we were constantly short UK rates, but we believe the market is priced more fairly today. We are not overly excited about emerging markets. Rather, we think the opportunities are much more selective. Brazil is one market that does stand out to us. Monetary conditions are tight, growth and now core inflation is starting to slow and concerns over President Lula’s fiscal plans are subsiding. We expect the central bank to start cutting rates in the coming months and to do so by more than the market is currently pricing.