Multi-Asset Credit Strategy Monthly Comment - August 2023

August could be characterised as a month of two halves, risk sentiment feeble across the board in the first two weeks, followed by a wave of buying driven by dovish comments by Central Banks and by an encouraging earnings season. In the month we had a further softening in the economic data, particularly in Europe and China, which has led to growing concern about the near-term outlook. At the same time, there has been rising speculation that interest rates are set to remain higher for longer, and earlier in the month we even saw the 10-year Treasury yield hit a new 10-year high but since Jackson Hole, we have witnessed a decent market reaction. 

This year’s annual Jackson Hole economic conference felt very different from last year’s when headline inflation was tracking above a roughly 8% pace in the U.S., and Powell signalled the Fed would march on with rate hikes without any suggestion of how many more might follow. With fears over what this could mean for the economy, recession obsession was mounting. Consumer sentiment was already battered, and the U.S. housing market was feeling acute pain. On the contrary, this year while Chair Powell stressed the job is not done, he stressed that inflation has cooled while growth has stayed this strong. Fed staff members are not expecting a deep and prolonged recession anymore and consumers are not as worried about the future. Meanwhile at the ECB, Isabel Schnabel of the Executive Board said that recent developments point to growth prospects being weaker than foreseen in their baseline scenario in the June projections. She also said that whilst further rate hikes could be warranted, there was also an acknowledgement that if their assessment of the monetary policy transmission suggests that the pace of disinflation is proceeding as desired, ECB may afford to wait until their October meeting. The policy debate has shifted from ‘how high’ rates should go to ‘how long’ the Fed and other central banks should hold them there. Markets are pricing in the first Fed cut for next summer.

S&P 500 earnings look set to contract just over -4% from the year prior, improving from the -7.3% expected coming into the quarter. The biggest worries from the last year also seem to be fading. Mentions of negative factors such as ‘inflation’ and ‘economic slowdown’ have fallen meaningfully, and most management teams seem pleasantly surprised by the durability of demand. Next 12-month earnings expectations for the S&P 500 have also been climbing consistently since March.

During August, the strategy posted a positive performance with all asset classes posting positive performance. With respect to strategy allocations, there were no major changes during the month and the strategy continues to be cautiously positioned. We maintain a portion of our P&L hedged to mitigate against potential volatility coming from an unexpected negative macro surprise. Valuations remains compelling across most risk assets and selected themes in credit are still interesting particularly in Europe. We expressed this view mostly via selected defensive BB rated credits and Tier 1 financials. We continue to think that BBB CLO tranches, yielding 7-8%, are an extremely attractive opportunity in the current market context. The portfolio managers conducted relative value switches from a bottom-up perspective. We would use any weakness to add risk, in particular in names with a clear fundamental risk premium - mostly in the cyclicals, selected CoCos and BBs -, which should continue to compress on strong fundamental tailwinds this year.

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