Having hit a near-record peak in 2022, the US dollar has since entered what may turn out to be another long-term bear market. We have increased our tactical positioning in cheaply valued non-US equities.
We retained our “quality income vigil” at our April Global Investment Committee meeting. Global equities are outperforming our expectations for corporate profits over the near-term, particularly in the US. At current prices, this leaves reduced upside to be earned from eventual recovery. We maintained a 1% underweight to global equities and 2% overweight to global fixed income led by US investment grade debt. We will reallocate to take greater equity risk exposures when the return outlook warrants.
While it is too soon in our view to reallocate for a US economic recovery, the near 40% valuation discount for non-US equities and prospects for a declining US dollar in coming years moved us to shift exposures toward regions with lower expectations. US equities trade at 19.4X expected 2023 EPS, while non-US shares trade at 11.8X. Non-US dividend yields are also twice the US level. EPS estimates are at risk to some degree everywhere, but confidence in US growth seems highest.
After a narrow rally, we neutralize our US large cap overweight and pharmaceuticals position which have outperformed. This allows us to invest an additional 3% in Asia, Europe and Latam (Brazil) equities (1% each). Within Asia, we have diversified more broadly after concentrating in China.
The Fed seems poised to “nail down” the US economy with an additional tightening step early next month. It is doing so while the Index of Leading Economic Indicators has fallen 8% and broad money supply is contracting for the first time since the late 1940s. The US has the most cyclical labor market among large, developed economies. The Fed has a history of the most radical changes in monetary policy. Other central banks may lag behind prospective Fed easing steps in 2024, weakening the US dollar.
Bull and bear markets for the US dollar have lasted as long as a decade. The USD reached its second highest level in history in 2022. While we would still expect periodic rallies in the US dollar – perhaps on hawkish messaging from the Fed next month – we believe the more the Fed tightens, the greater the likelihood it will ease more aggressively in the coming year.
We continue to believe that the limited gains the US and other key economies made since the Covid shock suggests only a mild recession or stall to come. Pent-up demand for services continues to buoy employment and growth measures, but the expansion is narrowing. The usual cyclical industries – construction and manufacturing – are already falling. As stimulus drove the US post-Covid recovery, private debt rose less than many fear.
A key battleground for investor views may not be the severity of the slowdown or recession, but how quickly and strongly the economy will recover. This all favors some immediate diversification from US assets, which have had the largest post-Covid gains. USD assets also bear some long-term risks as the US dollar already dominates trade flows and foreign reserves globally.