Our Global Fixed Income underweight was reduced from -3% to -1%, driven by the increase in our US fixed income overweight from 7.7% to 10.2%. Gold remains 2% overweight, with cash at 1% underweight. Since we eliminated our US high yield bond position in favor of loans early last year, loans have outperformed, returning -0.8%, while high yield bonds returned -8.5%.
With large future increases in Fed policy rates priced into fixed income markets, medium duration IG corporate bond yields have risen to about 4.8% from 1.8% a year ago. Sub-investment grade US yields have risen from 3.7% to 8.4%. With this move, we added a further 2% to our overweight in intermediate-term US corporate bonds and 0.5% to US high yield, the latter by shifting away from a small European position.
Our move leaves us underweight US high yield as a sub-asset class. We believe a potentially excessive level of future Fed tightening may cause a transition from interest-led risks in global markets to credit-led risks. In equities, we eliminated a thematic overweight position in oilfield services equities. While we would expect solid returns for this industry in the coming several years, the position was highly correlated to our overweight in other natural resources equities, including energy producers.
With downside economic risks building from aggressive central bank monetary policy tightening, we cannot rule out more significant declines in cyclical commodity prices such as oil and copper in the year ahead. However, we maintain our broader overweight of 2% in natural resources shares, given constraints on many food supplies and other essential commodities. The dividend income and hedging value of these equities remain attractive as Russia/Ukraine commodity supplies could stay severely constrained. We continue to believe in long-term returns from financial technology (fintech). However, along with our reduction in bank loans, cutting this position allowed us to establish a new thematic fixed income position in hybrid capital securities at +2.0% and an enhanced position in depressed China equities.
Preferred stock yields among investment grade financial issuers have risen to about 6.5%, well above bank common equity, yet higher up the capital structure. While some hybrid issues are rated below investment grade, the underlying issuers may be strong investment grade borrowers. Although the chance of recession is both increasing and reflected in market fears, we see the US banking system sufficiently well capitalized to absorb losses.
This is less true of some experimental fintech competitors and smaller traditional banks. (We remain underweight small- and mid-cap shares.) Apart from commodities, we continue to favor higher quality, less cyclical assets providing a source of returns: fixed income yields of investment grade government
borrowers and dividend payments from firms with strong balance sheets. We continue to overweight consistent dividend growth shares. In the US, these equities have fallen 12% this year compared to a 20% decline for the S&P 500 Index. Our largest industry overweight is pharmaceuticals, which has dropped 1% versus the 20% fall in the MSCI All-Country World Index.
Cyclical conditions of US and Chinese equities suggest the latter may recover sooner
In US equity markets, we continue to believe that shares discount a large rise in interest rates, but not a sharp decline in corporate profits. While we only forecast a 3% decline in US corporate profits in our base-case economic outlook for 2023, it is not clear how long the period of poor economic performance will continue or how severely the Federal Reserve will act to depress demand. The high level of US profits and employment makes us wary of expecting strong US equity returns, as profit margins are at risk.
We remain underweight European equities, particularly small caps given severe economic vulnerability to Russian gas supplies. The European Central Bank is also at an earlier stage of tightening monetary policy. (Given regional challenges, it should not be expected to tighten in lock step with the Fed). One exception to our concern about cyclical risk is China. Unlike the US, China’s economy is depressed, with very weak property and labor markets spurring an easing cycle.
Like in 2020, recent COVID restrictions pushed the local economy down sharply, but very likely in a temporary way, forcing policymakers to prioritize economic recovery. Prior to a recent, tentative rebound, Chinese share prices fell 54% from their early 2021 peak, leaving valuations depressed. We believe the contrasting policies and cyclical conditions of the US and China means Chinese equities can recover sooner. Export strength has not helped China’s shares in 2021-2022 to date, and external economic weakness is unlikely to derail their recovery. With today’s move, we’ve raised China shares to a 2% overweight from 1%.
As we expect interest rate pressures to peak in the US in 2022, we believe better capitalized and profitable firms in secular growth industries are becoming increasingly attractive compared to cyclical industries (shares represented more strongly in “value” style indices). As of now, it is unclear how the Fed and bond market will react to incoming inflation data, which we expect only to decelerate slowly. As economic risk is priced more acutely, we will watch signs that both interest rates and credit markets stabilize, with a view to taking greater equity risk at some future point.