• Equity allocation from underweight to neutral
• Soft landing increasingly likely in the US
  
• Japanese equities remain attractive

Stock markets were mixed in January, with developed market shares advancing while emerging markets saw negative returns. Global stocks (MSCI All Country World Index) ended January with a total return of 0.6%. The driving force behind this was a 1.7% gain for the S&P 500, buoyed by robust US economic data and the optimistic belief that rate cuts will bolster markets throughout the year. With a gain of 8.5%, Japan was the best-performing market in the month. Surprisingly low wage figures prompted markets to reconsider the probability of the near-term removal of negative interest rate policy (NIRP). In addition, perceptions of improved corporate governance may have boosted foreign interest in Japanese stocks. For fixed-income investments the atmosphere was less favorable as robust growth figures along with resistance from certain central bankers muted expectations for rate cuts. Both US and German 10-year yields moved slightly higher to 3.95% and 2.16%, respectively.

 

Equity market sentiment was positive for much of the month amid mounting hopes of a soft landing for the US economy. Fourth-quarter GDP growth of 3.3% surpassed the expectations of most economists. This depiction of vigorous growth has been further supported by recent signals of robust consumer sentiment, a resilient labor market, and the upturn in the purchasing manager indices (PMIs). Meanwhile, inflation data reassured investors that inflation is headed back to the central bank's target and that the Federal Reserve was on track to cut rates early in the year. However, market confidence was tempered by signals from the Fed during its policy meeting on January 31st that were perceived as more hawkish than anticipated. The Fed said the committee believes it will be appropriate to stick to the current target range until it has gained greater confidence that inflation is moving sustainably toward the 2 percent target. The remarks of central bankers disappointed those who were hoping interest rates would come down quickly. However, we think it is less relevant whether the Fed starts cutting interest rates in March or May. It is more important to maintain focus on the broader context, wherein sustained disinflation should pave the way for monetary easing this year.

 

The ECB kept interest rates unchanged at its January meeting. However, ECB president Christine Lagarde said that “the disinflation process is at work” and opened the door to lower interest rates as well. Growth in the Eurozone is still stagnating. It remains to be seen whether the stabilization in some early indicators points to a sustainable recovery. The Chinese economy continues to struggle as well. China's equity market fared quite poorly, with the MSCI China losing 10.4% in January. The sell-off is driven by ongoing weakness in China’s economy and a steady and ongoing collapse in investor sentiment. It seems that the weakness in the equity market has triggered the pain threshold for policymakers, who are becoming increasingly wary of a worsening feedback loop between deteriorating investor sentiment and a negative wealth effect in the real economy. Over the past few days, Chinese stocks have been showing signs of bottoming out as the government stepped in to bolster the market.

 

In our investment policy, we had been underweighting equities for some time, as we were concerned about the impact of sharp monetary tightening. While concerns haven't entirely dissipated, we have increasing evidence that the soft-landing scenario for the US economy is playing out. We've decided to increase our equity allocation to "neutral" and have opted to expand our overweight in Japan. Japan's monetary policy is still very loose. The trend in corporate profits has recently been stronger than in the US and Europe. Furthermore, an appreciation of the Japanese yen, which might serve as a safe haven in the event of unsatisfactory market or economic events, may provide some protection.

 

Please find attached our last Asset Allocation Update for February.