2022 saw a de-rating of risky assets due to the rise of interest rates. In 2023, earnings growth will be the catalyst. An earning recession is expected in the first half of the year, followed by a recovery. We think expected earnings will be revised downward again in the short term, but this will be an occasion to buy the dip because the bottom is not too far away.
This year, all asset classes have experienced significant drawdowns. After these movements, the relative attractiveness of the different markets has changed and, for the first time, investment grade bonds look attractive. With economic growth slowing and inflation coming down next year, investment flows could favour fixed income.
This year, the equity market has been heavily de-rated due to rising interest rates; the focus is now turning on earnings growth and the risk of recession. In the case of a mild recession, we believe that equity markets can recover slightly, but in the case of a severe recession, the downside risk remains significant. Therefore, we prefer a cautious allocation in the short term.
With the current markets correction, equity valuations are now more in line with the new scenario of higher interest rates and start to be attractive for a long-term investor. Market focus is changing from the derating of valuation to the risk of recession with the risk of Central Banks tightening too much. For this reason, we would prefer to see a clear change in the inflation trend before becoming more positive.
With the start of the war in Ukraine the scenario of strong economic rebound is not anymore live and the uncertainty high. With bonds and equities moving together for the fear of a stagflation scenario a high allocation to cash is advisable.
After a strong 2021, we see space for a good performance of European equities in 2022. Valuations are not as high as in the US, the economic cycle can remain strong and the ECB appears to be more supportive than the FED. The bond market is expecting a monetary tightening cycle in the US that will end at 1.5% of Fed Funds rate. We see a possible repricing at a higher level, but not a regime change with negative impact on risky assets.
After a strong recovery the economic cycle is starting to normalize. For the financial markets, the question is whether valuations are sustainable, and here a low interest rate environment is the key. Our view is of only a modest increase of long term rates, without a significant impact on other markets. High valuations mean low expected returns for the future and we favour better entry point to increase risky assets.
The economic recovery in the US is well underway and its acceleration should be close to maximum at this stage. Peak earnings growth, high valuations and the possibility of tapering by the Fed, leads us to recommend a more neutral allocation despite a positive macro scenario.
As vaccinations progress it is becoming evident that the US and UK are close to exiting the pandemic, while the Eurozone is around a quarter behind. With the end of the lockdowns, we will see a strong recovery that should maintain the positive trend of the more cyclical part of the equity market. However, uncertainty is emerging as to what the scenario will look like in 2022, with opposing views.
The current development of the pandemic shows a worsening over the short term (a second wave worse than expected) but, at the same time, the beginning of vaccinations. The financial markets are forward looking, and they react positively to the prospect of a return to normal thanks to the vaccines. The scenario of an exit from the pandemic allows to maintain a positive outlook on the markets, but valuations are starting to be high. We think as long as the mix of fiscal and monetary reflationary policies remain, valuations won’t be an issue.
The current economic conjuncture is defined by Powell as the “uncertain recovery”, the uncertainty being mainly linked to the evolution of Covid-19. This situation has not stopped the market recovery until August, but with the approaching Presidential election in the US and the risk of a new wave of infections in winter the volatility is increasing and the trend is no longer upwards. We are of the idea that a new long term cycle is starting and while in the short term it is better to remain cautious, buying the dip attitude is the right one. It is important also to look at the high divergences inside the equity markets. With the search for growth and the enormous liquidity boosting the growth stocks, value stocks are lagging as never before. This trend will finish when the economic recovery becomes more solid.
After the strong rebound of the financial markets during the last 3 months, many open questions remain. First, will the COVID-19 development lead to a new lockdown, stopping the economic recovery. Second, will the recovery be a V-shaped or experience a slow improvement. Third, are the market valuations too high in reflecting a too optimistic scenario. Our view is to consider a second lockdown of the economies as a tail risk but not the main scenario, with the economic recovery expected to be U-shaped and valuations high for the equity markets, less for the bond markets. The case for investing in equity should be mainly based on a long-term view on the earnings recovery.
2019 ended on a high note for financial markets, after the first step agreement between US and China reduced the risk of a trade war escalation. At the moment, the consensus scenario for 2020 indicates a macroeconomic environment similar to 2019 (weak but decent growth and low inflation). The main difference lies in the monetary policy, with the end of the easing cycle in the US and the Eurozone, which will reduce the expected return for the markets. But something always diverges from the consensus, and we try to point out what it could be.
After a strong first half of the year, last quarter saw a volatile equity market ending with a small positive performance. The policy easing implemented by the Central Banks was supportive, with lower interest rates generating positive performances in the bond markets and counterbalancing the weak economic environment for the equity markets. The key in the future will be the dynamics of earnings growth. It is at the moment close to zero, or slightly negative, and we don’t see the case for a reacceleration.
After a strong start of the year, the second quarter was again good for risky assets even if in May a return of trade war jitters generated a market correction, reverted back in June. Markets are supported by the Central Banks and are waiting for an improvement in growth which is expected for the end of the year. Many market participants are looking to the current slowdown as similar to the 2016 one, but we think the risk to be disappointed is high and a new market correction likely.
The start of 2019 has been very positive, and markets recovered more or less the losses of the last quarter 2018. The change of the Central Banks’ attitude is the main reason of this reversal, but the macro scenario is still unclear with the slowdown in global growth continuing. We are in a late cycle environment, where the future outcomes are asymmetric, with a limited upside if the global economy stabilizes and a sizable downside if a recession happens in 2020. For this reason we think it is time to reduce the exposure to risk.
The last months of 2018 were terrible for the markets.
While valuations on the credit side are less cheap compared to 2016, we still start the year with a higher carry than last year’s.
With such a kick off, what can we expect for 2019?
Whilst markets were very volatile during the summer, asset returns finished on the positive side on Q3. Risks we highlighted in the last Sumus’Version become relevant but the main trend remained positive. US assets (equity and high yield) have continued to outperform and the divergence with the rest of the world starts to be extreme. A relative performance recovery in Europe and in Emerging Markets is from now on possible.
Volatility is continuing to dominate the financial markets, even with slightly positive returns for equities during the last three months. The macro outlook is still positive, with growth in the US accelerating, but this time the expansion looks less synchronized as the Eurozone slows a little bit.
In the first quarter of 2018, the equity bull market stalled, with the US market finishing at -1% and European stocks in negative territory. Volatility spiked for the first time in the last two years and the markets experienced a correction of 10% for the first time since Q1 2016. On the high-yield side, the performance was negative but the spread widening not significant. As the one in August 2015 was, the correction we faced is uneasy to explain. Markets were frightened by inflation and by the growing risk of a trade war initiated by Donald Trump, but these are not enough to explain the market behaviour.
The last quarter of the year is likely to be another excellent one in terms of performance for equity markets. In the USA, the Tax Reform is close to be delivered, triggering a boost to future corporate profits. Indeed, US Equities have constantly surpassed new highs (+ 6% since the end of September), leaving European equities way behind with a poor 1% increase since the end of September. On the High Yield side, the performance is marginal.
In this Sumus’ Version, we will analyse the risk of a change in the scenario while investigating what makes Europe a laggard in the world of Equity markets.
During the third quarter financial markets continued to perform well, with lower spread on risky bonds and new records for the US equities, despite an increase in geopolitical risks (mainly North Korea) and many natural catastrophes (hurricanes and earthquakes). Performances were excellent for USD based investors or substandard for Euro based investors due to the sharp movement in the exchange rate, which became a key element to forecast. The questions are two now:
Can markets continue to rise?
Will the Euro continue to climb impacting the performance of European investors?