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Multi asset perspectives: The unique challenge of divided markets

GAM Investments’ Julian Howard outlines his latest multi asset views, exploring how stock market progress during Q2 was dependent on an excessively optimistic view of the universal benefits of artificial intelligence.

28 July 2023


Global equities as measured by the MSCI AC World Index rose 6.6% in local currency terms in the second quarter of the year. Stock markets – and specifically US stocks which account for around two thirds of the world index – surged ahead on the back of euphoria around the latest breakthrough in artificial intelligence (AI). Seven stocks accounted for most of the positive gains, namely Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla, revealing a distinct lack of breadth in the market. Whether AI will live up to its promise was highly contested but the stock market, at least until the final few days of the quarter, appeared to have made up its mind.

Similarly, market volatility as measured by the VIX index collapsed to just under 13 in June, a level last seen just before the Covid-19 pandemic. Despite this, reasons to be more generally concerned about the economy and markets were both more numerous and persuasive. The US debt ceiling deadline was only just met at the end of May as politics was set aside at the last minute to avoid the humiliation and chaos of a potential US default. More worryingly, inflation remains unvanquished across the major advanced economies. In the US, eurozone and UK, headline inflation was on a decelerating course but core inflation remained stubborn at 5.3%, 5.3% and 7.1%, respectively, by the end of the quarter. While the US Federal Reserve chose to ‘skip’ a hike in its June decision, there was little question of ending the current tightening cycle, while the European Central Bank (ECB) and Bank of England both hiked rates at their June meetings (the latter by 50bps) in a clear signal of intent. The uncertainty around the end-point of the inflation and interest rate saga that began in early 2022 shows no sign of lifting, a fact not lost on bond markets, whose own MOVE volatility index still remains elevated versus 2021.

Other potential risks included the continued travails of the US regional banking system which saw the failure of First Republic in early May and whose impact on lending into the real economy is just now starting to reveal itself. Geopolitics remained fraught too amid Ukraine’s counter-offensive, an attempted putsch by Russian mercenaries and simmering tensions between the US and China. The US Republican nomination process provided its own dramas as the leading candidate faced outright criminal charges. While the last few days of the quarter started to show a more consistent alignment as market volatility picked up amid all this, the review period as a whole was characterised by a marked divergence in markets.

Chart 1: Core of the problem – underlying inflation remains stubborn

Source: Bloomberg. Past performance is not an indicator of future performance and current or future trends. Data from 31 Dec 2012 to 31 May 2023. For illustrative purposes only.

Long-term portfolios face the perennial challenge of investing for the time horizon their description suggests while needing to provide a controlled journey through the short-term ups and downs that capital markets inevitably generate. It is important to focus on those areas which have a realistic possibility of generating growth in a low growth world of secular stagnation. In our view, this coalesces around (inevitably US) large cap technology stocks whose sizeable cashflows can finance their unrivalled innovation pipeline. We are also positive on emerging markets and China. While many analysts have lamented China’s slow recovery since its belated re-opening, we believe the country’s economic growth prospects remain far better than most advanced economies and its equity capital markets far more under-represented in world indices.

Away from equities, our focus is on consistency and reliability over outright growth. As such, we emphasise fixed income and credit strategies that are independent of the main bond markets. These include mortgage-backed securities, catastrophe bonds and subordinated financials. But we believe the best risk-reward (see chart 2) comes from short-dated fixed income in the form of ultrashort investment grade bonds and either treasury bills or money markets depending on reference currency. With discount rates across the key economies elevated and likely going even higher to deal with unvanquished inflation, we believe these instruments offer healthy yields with relatively little risk (US debt ceiling fiasco aside).

Chart 2: Why take on complexity and risk for the sake of it?

Source: Bloomberg. Past performance is not an indicator of future performance and current or future trends. Data from 31 Dec 2019 to 27 Jun 2023. For illustrative purposes only. Indices cannot be purchased directly.


Declaring the macroeconomic and investment outlook highly uncertain risks sounding trite but the reality is that markets are startlingly divided and at some point this will need to be reconciled. While we recognise the changes that AI is likely to bring to many workplaces, we believe that its paradigm-shifting qualities may have been overstated. The history of technology step-changes not universally characterised by huge leaps in growth and productivity. The academic literature for example is persuasive on the limited impact of the US railways in the 19th century while the modern concept of secular stagnation notably took hold in the years following the supposedly paradigm-shifting boom of the late 1990s. We still prefer large cap technology stocks for their qualities as ‘vendors’ of innovation into the broader economy over time but fail to share the breathless enthusiasm for AI’s purportedly transformational qualities.

In the meantime, the principal threat to the stock market, and indeed any series of cashflows that characterise a financial asset, is persistent inflation and the yet-higher rates that the major central banks will need to deploy to deal with it. Much has been written about lifting inflation targets as a means of side-stepping the ghastly spectre of tightening policy to the point of crushing demand and bringing spending almost to a stop in order to bring prices down to current targets. While this is intriguing it is probably also naïve: central bank credibility, already bruised after the belated start to policy tightening in 2022, rests on pursuing carefully thought through policies in a consistent manner. Our sense therefore is that discount rates in the US, eurozone and UK will continue to tighten, and therefore render most asset classes – equities included – even poorer value in the short term. While this has the potential for creating volatility in equities as high risk-free rates threaten to outright overshadow corporate earnings yields, the consolation is that short-dated fixed income offers a rare opportunity to potentially generate high risk-adjusted returns away from stocks. None of this renders a structural allocation to equities invalid. Indeed we believe they should be so for a reason – the ‘Siegel Constant’ of 6.5-7% observed real returns in equities over the last two centuries has been achieved net of periods just as disorientating as this one. The real risk is to believe something has profoundly changed.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and asssessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Past results are not necessarily indicative of future results. Investors could lose some or all of their investments.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark. This article contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

This disclaimer shall in no way constitute a waiver or limitation of any rights a person may have under such laws and/or regulations.

In the United Kingdom, this material has been issued and approved by GAM London Ltd, 8 Finsbury Circus, London EC2M 7GB, authorised and regulated by the Financial Conduct Authority.

Julian Howard

Lead Investment Director, Multi-Asset Class Solutions (MACS) London
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