Credit Suisse turmoil underscores defensive positioning

• The fast-moving financial markets saw the attention switch from fears of stickier-than-expected inflation to the banking troubles in the US and in Switzerland.
  
  
• Central banks have brought some support by providing short-term funding programs and have coordinated action to support US dollar liquidity worldwide. 
  
  
• That said, markets continue to be volatile on fast-moving developments. This can be seen by significant intra-day swings in the price of key risk assets, from the main equity indices to speculative (or high yield) bonds. SVB filing for bankruptcy late on Friday offset the relief coming from central banks’ support weighing on banking stocks and risk assets. UBS agreed on Sunday to buy Credit Suisse, which may not have entirely eased market participants’ fears.
  
  
• However, the risk-off sentiment has buoyed safer assets such as government bonds, which we notably increased in portfolios in the past 4 months.
  
  
• This week, the attention remains on central banks. The Federal Reserve (Fed) is expected to raise interest rates by 25bps. We think the Fed would only pause if financial stability risks were to dominate. Beyond headlines, this doesn’t seem to be the case as the banking turmoil reflects company-specific risks rather than systemic ones. 
  
  
• For instance, last week, the European Central Bank (ECB) pressed ahead with a 50bps increase as it deems inflation to be still too high. The ECB did turn fully data-dependent, though, abandoning forward guidance.
  
  
• The turmoil in the banking sector does add a new degree of uncertainty about the future path of monetary policy and leaves market pricing very sensitive to incoming news on the banking sector rather than to economic data.
  
  
• Elsewhere, the situation differs as growth matters too. In the UK, we expect the Bank of England to raise rates by a final 25 bps given weak growth prospects, confirming our view that central banks are close to stopping their increase in interest rates. In China however, the central bank cut interest rates in order to bolster its economic reopening, which supports our positive view on economic prospects for the Asia pacific region.

Focusing on our flagship portfolios, here are our key thoughts:

• We last week emphasised the deliberate move to increase the quality exposure within our strategy in the past six months, in particular by adding to quality government bonds in the US, UK and Europe, while notably reducing the high yield and emerging market exposure. Within equities, we maintained our preference for higher quality regions and investments.
  
  
• We did not foresee the problems of the US banking sector, but we increased the government bond exposure given the higher interest rates on offer, the unattractive equity valuations in riskier credit markets and generally the unappealing ones in some equity markets (e.g. Europe) amid a challenging backdrop for company profits.
  
  
• As markets remain volatile, our strategy continues to be relatively resilient in March, supported by:
  1) a more conservative fixed income positioning (higher than normal exposure in government bonds) which has been rewarded in recent weeks as government bonds have outperformed other assets
  2) our regional allocation as US equities, supported by a more resilient tech sector, have outperformed other regions such as Europe and UK equities which we are less exposed to
  3) and the quality bias of a number of investments, including our in-house single line equity portfolio and a number of third party active and passive sustainable funds
  
  
• We maintain this overall stance for now and stand ready to adjust portfolio allocations should the prevailing macro and market environment present opportunities.

Past performance is not a reliable indicator of future returns.