Has the US dollar peaked?
The DXY dollar is about 8% down since its multi-decade peak in September and has given up almost half its gains for 2022 as a whole. While we believe bounces in the dollar are possible in the near term, the peak is likely behind us and dollar strength is running on borrowed time. First, while the Fed remains in inflation-fighting mode, the US tightening cycle is moving closer to completion—especially given the recent slowing of inflation.
Meanwhile, the tone from other top central banks, including the European Central Bank, has become more hawkish. China’s reopening trajectory shows signs of greater progress. This leaves room for economic growth outside the US, particularly in Asia, to stay more robust, thereby undermining a richly valued USD. The large US current account deficit, USD 251bn or 4% of GDP in the second quarter, means the US still needs to attract capital, and better growth prospects outside the US makes this harder. While growth risks to Europe remain, elevated natural gas storage levels lessen the threat from energy prices to growth and on the trade deficit. As a result, we have moved the US dollar to neutral, and we recommend starting to position for the inflection point. We favor selling upside risk on the dollar, including against the euro. We remain most preferred on the Swiss franc.
Is there more tech downside to come?
Global tech stocks have come under renewed pressure in recent weeks, with a rally from the 2022 low of October running out of steam. This partly reflected renewed worries over the outlook for higher interest rates. Despite a roughly 30% fall in tech stocks in 2022, the sector is still not cheap, in our view. The forward price to earnings ratio of about 20 times for the MSCI World tech index is still a 10% premium relative to the 10-year average, as of 19 December. It also compares to a PE of 14.9x for the broader index.
In addition, we expect earnings to decelerate further, as both businesses and consumers cut back on tech spending. But while we maintain a near-term defensive stance in our positioning, adding some cyclical exposure on further signs of bottoming should reward investors in the medium to longer term.
Is now the right time for alternatives?
High equity-bond correlations have made it difficult for investors to diversify and earn positive returns in 2022, but one bright spot has been hedge funds. The asset class has overall outperformed global equities and bonds in 2022, with the HFRI Fund Weighted Composite Index down just 3.4% in the first 11 months of this year. Some strategies, like macro, have even achieved strong positive returns. We continue to see hedge funds as well-placed to navigate upcoming market volatility and potential setbacks as central banks continue to tighten.
We also think private markets offer a differentiated source of returns, especially in challenging times for public markets. US private equity markdowns on average only reflected 55% of the S&P 500 drawdown in the last three recessions, as measured by Cambridge Associates US Buyout. Second, private investment managers have greater flexibility in adjusting to downturns, including by cutting costs, delaying capital spending, and using other levers such as securing additional financing or injecting additional equity.
Investors should of course remember that investing in alternatives like private equity comes with certain drawbacks, including the risk of illiquidity, and investors need to be willing and able to lock up capital for longer.
For more topics, see Top 10 questions answered.