Slow food for thought

Insights and research on global events shaping the markets

2023 started with a mirror image of the trends that prevailed last year: the US dollar is weakening, bond yields are falling and stocks are rising. Are we witnessing a classical positive seasonal effect or is the improving sentiment a reflection of a macroeconomic and fundamental outlook improvement?

While inflation seems to have peaked in the US, central banks need to keep tightening for a while in order to bring it closer to their long-term target. This would probably imply a recession, with a negative impact on earnings growth.

While we believe that equity markets remain in a downtrend, the weight of the evidence leads us to upgrade our one-month tactical view on equities from “unattractive” to “cautious”. Our view on EM Asia equities moves from “cautious” to “positive”. We are also upgrading our stance on credit from “cautious” to “positive” (though favoring Investment Grade).

Our main scenario is a rise in downside risks for the global economy, amplified by antagonist policies. This is due to a global growth slowdown that governments aim to mitigate through fiscal support, as well as a simultaneous inflationary environment that central banks are trying to contain. This combination spurs macroeconomic volatility which itself keeps asset price volatility elevated. Consequently, we maintain an “unattractive” stance on equities and a cautious view on both rates and spreads. We are positive on commodities and have a very attractive view on hedge funds. We remain positive on the dollar against all currencies as the greenback remains the only true inflation hedge at this stage.

Global equity markets declined in August, ending the rebound that began in July. Most of the economic data released last month points to an economic slowdown. Central banks are choosing to ignore this as they focus efforts on fighting inflation amid an energy crisis of historic proportions. Meanwhile, market trends remain bearish as market breadth deteriorates. In this context, it is not the time to be brave in asset allocation choices. Market bounces are likely to be part of a more volatile environment which will continue until the conditions for a market bottom are met.

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13/09/2022

High inflation has precipitated a slowdown in developed economies’ growth, with Europe facing the highest risk of stagflation due to the ongoing energy crisis. Central banks face a dilemma of high inflation and slowing growth, but remain on the hawkish side for the time being. The ECB is probably facing the most complex situation. While fiscal intervention might come to the rescue in order to cushion the blow from rising energy prices, political uncertainty is high as we enter the second half of the year: US mid-term elections, shockwaves in Europe from the war in Ukraine and sanctions on Russia, elections in India and Brazil are likely to keep financial markets' volatility at high levels.

Central banks have to re-learn to live with inflationary pressures and to normalize their monetary policy. Households are concerned by a decline of their real purchasing power, but healthy consumption levels can hold as long as unemployment remains low and wages increase. Businesses are seeing their profitability threatened by rising input costs. The trajectory of inflation in the months ahead will be a key variable of the economic environment.

Global equity markets are nearing bear market territory, being down nearly 20% from their recent peak. The acceleration of the market pullback seems to indicate that investors are starting to anticipate a “hard-landing” of the global economy. In other words, they fear that central banks will fail to tame inflation without triggering a recession or sharp economic downturn. This risk shouldn’t be dismissed. However, we believe that the “soft landing” scenario has merit.

Our leading indicators (macro & fundamental) continue to point towards challenges for equity markets. From a technical standpoint, the long-term equity bull market trend is being challenged while market breadth is not showing much signs of improvement. In Fixed Income, we remain cautious on rates and keep a disinclination stance on credit spreads. In Forex, we keep a disinclination stance on the EUR. Our “core” scenario for 2022 is adjusted towards weaker growth and higher inflation. Our leading indicators (macro & fundamental) continue to point towards challenges for equity markets. From a technical standpoint, the long-term equity bull market trend is being challenged while market breadth is not showing much signs of improvement. In Fixed Income, we remain cautious on rates and keep a disinclination stance on credit spreads. In Forex, we keep a disinclination stance on the EUR. Our “core” scenario for 2022 is adjusted towards weaker growth and higher inflation.

We have been gradually reducing our exposure to equities and credit over the last few months based not only on fundamental & technical indicators but also on systematic risk balancing. As a further step in this de-risking process, we are downgrading our equity view by another notch, from cautious to disinclination. We believe that a clear reduction in exposure to European markets is warranted in a context of huge uncertainty created by the war in Ukraine. We chose to sit on the sideline and wait for more visibility, on the geopolitical, economic and corporate earnings outlook.

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