Tug of war

Since the outbreak of the corona pandemic two and a half years ago, we have observed massive distortions and new extremes in various macroeconomic data, time series and statistics. Volatility in macroeconomic data is exceptionally high by historical standards and visibility is therefore limited. The development is not surprising, because since the Second World War we have never experienced a globally coordinated stimulus comparable to the one after the corona crisis. We are still feeling the consequences today – thirty months after the start of the pandemic. The best example is the United States, where the unemployment rate has fallen to a record low of 3.5%. At the same time, American economic growth has contracted for two consecutive quarters, implying a technical recession. Moreover, the war in Ukraine, the conflict with Russia and the related energy crisis in Europe as well as the geopolitical tensions between China and the US are creating additional uncertainty. On stock markets, the complex situation is causing a fierce tug of war between optimists (bulls) and pessimists (bears), while record high inflation in the Western world remains the determining factor.?

Sticky inflation

Falling US inflation expectations have optimists hoping that inflation rates will normalize as early as in the coming quarters (graph 1). This would give the Federal Reserve (Fed) more flexibility and it could either pause interest rate hikes at the end of the year or even terminate the hiking cycle.

Pessimists counter that headline inflation will weaken, but the core rate is likely to remain stubbornly high. In this case, the US monetary authorities will have little room for maneuver and they would have to raise the key rate close to 5%. We believe that inflation will remain sticky in 2023, but will stay at below 5%, which should provide some relief for the Fed.?

In Europe, on the other hand, the situation looks significantly different. Inflation expectations have risen further due to the energy crisis and the upcoming winter. The dependence on Russian gas and the geopolitical situation make for a dangerous cocktail that increases the risk of a binary outcome.?

Growth expectations remain under pressure

In the current environment, characterized by enormous challenges – the fight against inflation, the withdrawal from ultraloose monetary policy (quantitative tightening), the war in Ukraine and the energy crisis in Europe – global growth prospects remain under pressure. The likelihood of a recession has increased on both sides of the Atlantic in recent weeks. If the energy crisis continues to worsen a downturn seems inevitable in Europe.?

Investment strategy – caution seasonality

Both the Federal Reserve and the European Central Bank (ECB) are raising interest rates while economic growth is cooling. The tipping point in the US is the labor market, where unemployment is currently at a record low of 3.5%. In Europe, the picture is dominated by the sharp rise in energy prices, which acts as an additional tax on consumers and threatens companies' production processes. With growth in China also weakening, the world's second largest economy will not be able to help the West out of the misery in this cycle.?

We expect continued high volatility in all asset classes. Over the next six to twelve months, we prefer equities to bonds and alternative investments to liquidity. Following the recent weakness in gold, we see medium- to long-term potential for the precious metal. However, it is still too early for a broad risk build-up – not least because of seasonality as September to October are historically weak and turbulent months on international stock markets.

Equity strategy

After a valuation adjustment through a P/E compression in the first half of 2022, the focus is now on corporate earnings estimates, which are likely to come under pressure due to weaker economic growth and higher input factors. After a rally of almost 20% in the S&P 500 Index, we reduce our rating on US equities from “attractive” to “neutral”. At the same time, Europe remains unattractive. At present, the dots of color should not so much be set on a regional level, but within sectors and industries. After the strong rise of the Nasdaq indices, we downgrade the technology sector to “unattractive”. Within the financial sector, we favor insurance stocks (“attractive”) over banks (“unattractive”). Furthermore, we add gold mining companies to our preferred topics.?

Fixed income strategy

Despite the slight rise in interest rates along the entire yield curves of Western economies, the yield potential remains limited and, with the exception of the US, real yields continue to be negative. With the current hawkish positioning of the US central bank and the ECB, we maintain our neutral stances on government bonds and duration. Within the credit segment, we prefer corporate bonds to high-yield bonds. Our preference list also continues to include very selective subordinated corporate bonds (hybrid bonds).?