Challenges

As the second quarter of 2023 draws to a close, the longest day of the year is already behind us in the northern hemisphere. For investors, the question now is whether the third quarter will follow on seamlessly from the first two. In the coming weeks, capital markets and investors will have to deal with the following challenges: the monetary cycle, corporate earnings and consumer behaviour.

Over the summer months, investors will need more clarity on whether the Federal Reserve’s (Fed) tightening cycle is in its final stages and whether the European Central Bank (ECB) has also completed the bulk of its rate moves. A resumption, as we have seen in Canada and also in Australia, would be very unsettling for the markets and lead to an increase in volatility. We maintain our view that the US and the eurozone have done most of their rate hikes and are now in a wait-and-see mode.

The upcoming earnings season will give us a better insight into the outlook for the second half of the year and will show which companies can cope with weak global economic growth of 2% to 2.5% as well as continued high price pressure. Margin preservation is increasingly coming into focus as not all companies are equally well positioned to cope with the rapid and steep cycle of interest rate hikes by the Fed and the ECB. In addition, consumption and in particular US consumer confidence will play a key role in the second half of the year. The savings accumulated as a result of the fiscal stimulus in the wake of the corona pandemic are gradually drying up in the United States. As a result, the Fed is relying not only on headline inflation but also on core inflation to fall further in the coming months. The direction remains very important for the market sentiment.

In this environment, we maintain our defensive positioning: we are reducing the underweight on the equity side, but at the same time downgrade hedge funds. This follows our upgrade of European and emerging market equities in the first half of the year. The move also implies that we will continue to increase the equity allocation in the event of any major setbacks, or tend to build positions during periods of weakness. However, despite this tactical adjustment, selection remains crucial in each asset class.

Macroeconomic environment

The macroeconomic environment provided little positive news for investors on an absolute basis last month or in the second quarter. Instead, markets focused on the relative improvement, which was less bad than expected as reflected in the surprise indices for the US and the eurozone. We continue to expect the mix of growth and inflation to stabilise. This assumes that inflation continues to fall steadily and that GDP growth expectations for the next four to six quarters do not deteriorate. The main concern remains the development of core inflation, which is still far too high for central banks, especially the Federal Reserve.

Investment strategy

Given the macroeconomic backdrop, we maintain our cross-asset preference for bonds over equities. Bonds remain overweight in a multi-asset portfolio. On the other hand, we are reducing the underweight in equities as a first step. At the same time, we are downgrading hedge funds from overweight to neutral. This increases the portfolio’s risk only slightly. Despite this change in tactical allocation, selection remains the focus and thus an important success factor in all asset classes.

Equity strategy

At a regional level, we favour emerging markets, followed by Europe and the US. In terms of sectors, we upgrade materials from neutral to overweight. The other three preferred sectors remain energy, materials and healthcare.

Bond strategy

Bonds remain overweight in a multi-asset portfolio as risk-adjusted return expectations are still attractive. Within the asset class, we favour government bonds and investment-grade corporate bonds, which we clearly prefer to the high-yield segment. On a very selective basis, we also see potential in fallen angels. We have a differentiated duration strategy and are slightly long in US dollar, neutral in the euro and slightly short in Swiss francs.

Currency strategy

In the short-term, currency markets are closely following and positioning themselves around the communication from the major central banks – the Fed, the ECB and the Bank of Japan. The bottom line is that the Federal Reserve, in particular, has left no doubt that it will fight inflation by any means, including further interest rate hikes if necessary. Although the greenback looks fundamentally expensive against both the euro and the Japanese yen, Fed Chairman Jerome Powell’s hawkish communication is supporting the US dollar, at least in the short-term. The volatile sideways trend is likely to continue.

Alternative investments

We remain overweight in alternative assets, but have reduced the hedge fund allocation to neutral. The overweight stems from our positive view on gold. After the recent price weakness caused by the rise in US real interest rates, the precious metal should be bought in the medium to long term. Between 1 850 and 1 900 US dollars, we recommend adding to the position.?