Written by Jason Borbora-Sheen, co-Portfolio Manager, Ninety One Diversified Income Fund
Tight monetary and liquidity policy remains the focus in the US, and we believe the full impact of this policy has yet to fully play out across markets. Given the lags with which these operate on the economy we expect this will only become visible over the next few quarters.
While equities have derated, we are not convinced that they have priced in a full-blown recession and at the index-levels are instead valued for a soft-landing. While it is true that services demand remains strong, unemployment low, and balance sheets strong, we believe that the conditions to bring inflation fully back to target (rather than just off its peak) are not yet in place and this will entail at best a capping on equity upside, and at worst a meaningful earnings slowdown.
We remain positive on the income style which failed to participate in the liquidity-led re-rating of equities in the 2020-2021 period and now trades on some of the lowest valuation multiples levels since the global financial crisis. Many resilient dividend companies have pricing-power and the ability to raise dividends in the current environment. We also view Asia ex-Japan equities as attractive, with the region emerging out of a policy tightening cycle, regulatory headwinds in China showing signs of abating and compelling valuations. We see the income style and Asia ex Japan equity as providing the best opportunities for relative and absolute returns.
At the sector level, we remain cautious on the most expensive growth areas but have started to find some value in traditionally defensive but interest-rate sensitive sectors (such as REITs) that have derated significantly. We continue to prefer a combination of quality and value with a rich opportunity set presented by the Healthcare sector.
We downgraded Consumer Goods, to maximum negative, from negative last quarter, fully reinstating a long held negative view on the sector as cyclical challenges intensify for even those sub industries which have been relatively immune to the ongoing real income squeeze and inventory management challenges. In particular, we have moderated our positive view on home improvement retail where structural factors remain supportive, but the combination of a sharp housing slowdown and historic demand pull forward are starting to weigh on growth.
Overall, we believe equities will face continued pressure as earnings expectations – which remain at all-time highs – adjust to a cyclical weakening in demand alongside a substantial inventory challenge.
