Meet One of the Managers Who Still Thinks 'Cash is King'

After weak performances in the past two months, investors find themselves at a crossroads pondering whether it's time to re-evaluate their positions

Kate Lin 25 October, 2023 | 9:07AM
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Kate Lin: Welcome to Morningstar. After weak performances in the past two months, investors find themselves at a crossroads pondering whether it's time to re-evaluate their positions on US and European equities. The recent market corrections have also put stocks back to an attractive level. While recessionary fears continue to loom, volatility has left many wondering if a more cautious approach is needed.

Joining me today to make sense of the recession indicators and their impact on the equity and fixed income market is Ben Bennett, investment strategist for APAC at Legal and General Investment Management.

Will There Be a Soft Landing?

KL: Hi Ben. With the surge in yields on long-dated US bonds underway, do you think this indicates a lower chance of the economy achieving a soft landing? What signals are the recession indicators sending?

Ben Bennett: In a word, yes, I think there is a lower chance of a soft landing. In other words, I think there’s a higher chance of a recession in the US. If you look at the backdrop, we've had a still very low unemployment. The labour market is very tight and inflation is still sticky. And the Federal Reserve has been hawkish, has been saying, "look, we need to keep interest rates up to try and sort this out." Markets and investors have reacted to that, pushing interest rates up. We know that interest rates going up ultimately do weigh on markets, don't they? And with a lag.

I think the best reason why we haven't or the reason why we might hope that we don't get a recession is that we haven't had one so far. But that's not a great reason. In a normal cycle, this is about the time, after the Fed has started hiking when we would expect to see a recession. So right about now is the pinch point. And I would say that, with interest rates at the highest level that they’ve been all cycle, the dollar is quite strong. This is now the most pressure the US economy has been under for a recession. So that would be our base case going into the end of the year and next year.

And we're looking at lower sentiment, consumer sentiment being a forewarning of that, and also some credit stress in parts of the market. That's the things that we would believe to be signaling a recession.

Avoid Equities, Buy High Yield Bonds

KL: How do these views align with your underweight position in developed market equities? Into 2024, under what circumstances, would this position change?

BB: Yeah, it's totally in line with underweight equities because in a recession you'd expect to see earnings come down 20-25%. So, on that basis, equity markets could fall 20-25%. That's on average. I’d say, roundabout now, we've actually had quite a good year, haven't we? In 2023, equity markets are up, the S&P is up more than 10%, and Euro stocks are also up. So valuations are quite high. I think positioning and sentiment are also quite elevated. So I do think that equity markets are vulnerable to a potential downside shock. So that's why I think there’s quite a high risk that we do get a downshift.

Now look, if we get a soft landing, if we still get a soft landing. That's possible because this cycle is unique post-Covid-19, all sorts of things are going on, and then equity markets could rebound. But I don't think that the upside for equity markets, maybe that's 10-15% for the S&P 500. That's lower than the downside risk, the 20-25% chance. Even if you don't believe there's a recession, there's a good reason for you to be cautious about equity markets.

To change that view, we're going to have to see the recession dissipate. We'd have to see inflation come down without unemployment increasing markedly. But like I said, that would be very unusual. But that's something we’ve got our eye on, but that's something we've got to pay a lot of attention to.

Cash is Still an Attractive Alternative

KL: I assume now fixed income is still preferred. And what does your allocation look like between equity and fixed income?

BB: Yeah, we prefer fixed income. Look, US cash short-dated interest rates are at 5%. So cash is king here. You've got to get above 5% in order to sell your cash and buy something else. I would buy here as well some longer-dated interest rates, because if there's a recession then longer-dated interest rates will do quite well. But that's probably the only major part of fixed income that you’d want to be overweighted that we want to be overweight.

In investment grade credit. So a little bit of better risk added on to that long duration. That's also a possibility.

If you think there's a soft landing, then I do think high-yield and emerging markets would do very well under that scenario. So maybe that's another part of fixed income that you want to have a little bit in for that upside risk. And I do think that the returns for emerging markets high yield under that scenario would be better than for equity markets. So, so that's what we would have. But really right now cash is king.  

Lin: Thank you so much, Ben. For Morningstar, I'm Kate Lin.

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Kate Lin  is an Editor for Morningstar Asia, and is based in Hong Kong

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