As we get closer to turning points, both on the economic growth and on the monetary policy sides, uncertainty reaches its peak. Geopolitics have come on top of this already uncertain environment, compounding a challenging combination of high bond yields and slowing economic growth. Higher yields have continued to be the main gravitational force for equity markets and current yield levels have historically proved challenging for equity market performance. On the flip side, current yield levels bring opportunities in government bonds.
Higher yields also have an impact on the economy. As mentioned by a few Federal Reserve voting members, it resulted in meaningfully tighter financial conditions. Among other things, this has notably an impact on the biggest engine of global growth, a.k.a. the US consumer. In our macro article, we take a closer look at the state of US consumption.
As already mentioned previously, yields continue to be the major driver for equities. This is reflected in valuation multiples, which come under pressure with yields that elevated. But this does not mean that there is no opportunity in equity markets. After the correction, we see limited downside and discuss parts of the equity markets which could provide a strategic hedge. Gold mining stocks is one of those hedges in our opinion.
Talking about gold, we also revisit the investment case for the precious metal in our currency strategy. Gold is a non-yielding asset, therefore it tends to suffer when real yields are on the rise. But the past few weeks have emphasized once again the importance of geopolitics in the dynamic of gold prices. We review the main drivers to consider when assessing gold prices.
Finally, in our fixed-income strategy, we debate the relative value of credit spread. Until now, we had a relative preference for investment grade credit in our multi-asset portfolio while we were very cautious of high yield. Although we see no cause for panic in investment grade, we think that the risk-reward is more balanced than a few months ago and move our allocation to "Neutral".
The global economy continues to weaken, continuing its marked slowdown since the middle of the year. At least US consumption has recently proved to be encouragingly robust, and Asia and Europe have recovered somewhat from the disastrous momentum their growth has suffered since early summer. The headwinds of restrictive monetary policy in developed economies continue to act as a drag on virtually all areas of economic activity. Against this backdrop, we expect only very meagre growth rates for the final quarter of 2023 and the first quarter of 2024.
Yields movements continue to influence the performance of risky assets. Correlation between higher yields and equities continue to be strongly negative. But we do not expect yields to move meaningfully higher from here. They already contributed to a significant tightening of financial conditions. With a slowing economy, we prefer to earn safe yields in cash and reduce our investment grade positioning from "Overweight" to "Neutral". We also like the asymmetric return profile government bonds start to offer.
Over the past three months, equity markets have come under pressure. Here, we consider the recent rise in government bond yields as the main gravitational force, which triggered a valuation contraction in the world equity index of almost 10%. While the risk/reward ratio has marginally improved as a result of this valuation contraction, we maintain a neutral view on equities combined with a defensive sector bias. For risk-tolerant investors, we consider gold mining stocks an appealing addition for the purpose of hedging against geopolitical and economic risks.
As the economic cycle progresses and the positive momentum in debt ratios started to fade, we believe the likelihood of credit spreads widening has increased. We are therefore reducing our positions in investment-grade bonds with benchmark maturities and downgrading the segment to "Neutral" overall. Within this segment, however, we continue to favour shorter-dated bonds, as they generally carry a lower degree of credit risk. We remain "Overweight" in government bonds, where we prefer a slightly longer duration than the corresponding index.
In our examination of gold, we consistently take into account factors such as valuation, economic indicators, and technical aspects. However, it is of paramount importance to also integrate geopolitics into this analysis. Recently, gold has experienced a significant upturn, notably in response to Hamas’ attack on Israel, even as US interest rates have been on the rise. This underscores its role as a safe-haven asset. Additionally, the historical correlation between gold prices and the S&P 500 index indicates that economic downturns could lead to an increase in gold prices.