Our View in August

Published:23 August 2023 14:52 CET
Analyst:
Nadiia D, Content Manager, nadiia.d@adviscent.com

Expectations change. Sometimes the different views converge. At the moment, however, they tend to diverge. We remain in the cautious camp and prefer bonds to equities.

On financial markets, it is expectations that are traded. In the short term, it is usually not at all decisive whether a company made a profit or a loss in the last quarter. It is rather a question of whether analysts' estimates are exceeded or not.

The current round of quarterly results in the USA would actually have been predestined to boost the markets. On average, the profits of more than four-fifths of the companies in the S&P 500 equity index fell by almost 8%. But still, the majority fared better than feared. In the last five years, beating expectations had led to an average rise in share prices of 1%. But not this time: prices fell by an average of 0.5%.

Perhaps the expectations were not as negative as the numbers indicated. Positive surprises were already priced in, so to speak. We all know that. You prepare for the worst case scenario, but hope that it won't turn out quiet so bad.

Analysts have recently been less unanimous about what will happen in the coming months. For example, the range of year-end forecasts for the S&P 500 is currently almost 50%. The most optimistic and the most pessimistic analysts have not been this far apart in 20 years. In other words, uncertainty is high.

There are good reasons for both camps. However, we still see better arguments for aligning the portfolio defensively. This means holding a higher proportion of cash and bonds than usual, and fewer equities in return. Especially in US equities, there are signals that the market has run too hot.

Portfolio

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Strong Overweight
Neutral
Strong Underweight
Opportunities
  • The US Federal Reserve is expected to have raised interest rates for the last time in July
  • Corporate results turned out better than analysts expected
  • The US economy is still holding up well
Threats
  • Prospects for the global economy remain difficult despite US resilience
  • Market assessments diverge more strongly again
  • Equity and credit markets reflect too much economic optimism
Economy
Economy Overview

China as a reflection of the weak global economy

The growth of China's gross domestic product (GDP) for the second quarter is proof that the global economy is not in good shape at the moment. The GDP growth of 6.3 % may seem extremely dynamic, but the previous year's number had fallen, so the low basis for comparison was the reason for the high growth rate. In fact, the post-Corona recovery of the economy already seems to be faltering. The export-driven Chinese economy is suffering from weak demand in Europe and the US. A struggling China, in turn, is not good news for the global economy. Given the high share of investment in GDP, the Chinese government will not be able or not willing to launch a major investment programme. Not least for this reason, our outlook for the path of the global economy remains gloomy.

Opportunities
  • Revenue is normalising in the service sector
  • Recession in the US is delayed further
Threats
  • Eurozone is already in recession - southern countries are doing better than northern ones
  • Difficult outlook for the global economy despite some brightening
Monetary Policy
Monetary Policy Overview

Diverging paths

The central banks of the US and the eurozone, the Fed and the ECB, are likely to go separate ways from now on. The Fed probably delivered its last interest rate step  in July, while further hikes will be necessary at the ECB due to a stubbornly high core inflation rate. The Fed has probably done its job for this cycle thanks to a significant fall in the inflation rate and a core inflation rate that is also easing. In the US, the key interest rate is now clearly above the inflation rate, which means that the Fed has entered restrictive territory. This is not yet the case for the ECB. Inflation rates in the eurozone are still above the policy rates. In our view, the Swiss National Bank (SNB) is also likely to decide another interest rate step in September. Then, thanks to relatively low inflation rates, the policy will also be restrictive, which would speak for an end of the monetary policy tightening course.

Opportunities
  • The Fed has reached the interest rate peak
  • The SNB can advance into the territory of positive real interest rates
Threats
  • High core inflation rate forces the ECB to raise interest rates further
  • Risk of financial market stress remains elevated due to restrictive monetary policy
Bonds High Grade
Bonds High Grade Overview

US yields under the spell of Fitch

The downgrade of the credit rating of the US from the top AAA to AA+ by the rating agency Fitch put some pressure on government bonds. Yields rose to levels of almost 4.10 % in the 10-year maturity range. However, we do not expect the lower credit rating to have a lasting negative impact on US government bonds. The rating downgrade is mainly justified by the agency with an erosion of governance. By this, the Fitch analysts refer to the problems in passing the budget and the various crises in raising the debt ceiling. So it is political and not economic reasons that have led to the downgrade. Since Treasuries are without alternative due to the sheer size and liquidity of the market, there should be no lasting damage. The main drivers of US government bonds remain inflation and the interest rate path.

Opportunities
  • If there are risks of recession, yields at the long end of the yield curve will not rise significantly
  • Record-high forward sales of US government bonds serve as a contra-indicator and suggest falling yields
Threats
  • Inflation rates above target could force the ECB to tighten for longer
  • Deterioration in credit ratings may briefly come to the forefront of investors' minds
Bonds Investment Grade
Bonds Investment Grade Overview

Less interest cost despite rising rates

While the interest burden for the US Treasury has almost doubled in the last three years, especially large companies are not (yet) feeling the pressure of rising interest rates. This is because they have issued long-term bonds during the period with low-interest rates. At the same time, cash holdings can be invested at higher yields for short maturities when the yield curve is inversed. For smaller companies, which tend to have less cash holdings on their balance and more floating rates and shorter maturities, the situation is exactly the opposite. However, we do not expect the current situation to last much longer. A recession is likely to be imminent and more severe than currently expected in the market. The decisive factor will then be the strength of the balance sheets. The focus will be on those who can weather the storm with as little damage as possible. Sound credit analysis is becoming more important in this environment.

Opportunities
  • Economic engine running smoother than expected
  • Declining inflation rates, but risk of a second inflation wave remains
  • Interest rate hikes in the US are likely to be over
Threats

  • Investment-grade corporate bonds yield about the same as risk-free Fed fund rates
  • Our scenario of a hard landing still has a high probability
  • Safety is in demand, buy corporate bonds only with top credit ratings

Equities
Equities Overview

Earnings season brings some clarity

After the strong run of the equity indices, especially in the US and in the technology space, the focus has shifted to half-year earnings. After all, valuations have risen since the beginning of the year and in order to underpin the price movement, expectations would at least have to be met. Across the regions, analysts' estimates have been exceeded on average. However, while growth was also positive in the US, results in Europe shrank year-on-year. This fits the picture painted by weak European leading indicators. But even if the half-year results turned out better than feared, mid-sized US industrial companies have yet to report which should provide a clearer picture. Whether they show convincing figures will also be decisive for the further recovery of the market breadth.

Opportunities
  • Increased market breadth thanks to cyclical small and mid caps
  • Half-year figures better than analysts feared
  • End of interest rate hikes in the US
Threats
  • Leading economic indicators point to recession, which equities do not reflect
  • Slowing recovery of China's economy affects European stocks
  • The end of the interest rate cycle may have been anticipated
Equities Switzerland
Equities Switzerland Overview

Weakening economy leaves its mark

As in the rest of the world, the focus since the beginning of July has been on earnings for the first half of the year. The revenue of the companies whose shares are included in the broad Swiss Performance Index (SPI) was not only weak in absolute terms, but also surprised negatively on average. The continued strengthening of the Swiss franc was partly responsible for the weak growth. However, the main driver is a generally deteriorating economic picture, so that even the rather defensive luxury sector had to struggle with declining sales in the US. In addition, some suppliers also reported declining orders. In the course of the reporting season, there were also profit warnings and, despite good half-year results in some cases, only a few companies increased their outlook. What speaks in favour of the Swiss market, however, are valuations, which are still lower compared to the US.

Opportunities
  • Better half-year results than expected
  • An end of interest rate hikes could have a positive impact
  • Lower increase in valuations than in the US
Threats
  • Appreciation of the Swiss franc has a negative impact on corporate results
  • Weak economic data for Europe and China are being felt by Swiss companies
  • Hardly any increased outlooks
Alternative Investments
Alternative Investments Overview

Post-pandemic economic environment

After 11 interest rate hikes from 0 to 5.5%, economic theory would have the US economy in recession, unemployment rising, house prices falling and the stock market diving. None of this has happened so far. Nevertheless, the market assumes that interest rate hikes have peaked. But what if the mass is wrong and inflation turns up again, as it has so often in history? The Covid pandemic has rewritten economic models, and the labour market will probably never again be comparable to the pre-Covid era. For markets, this unpredictability means risk. Trend following systems (CTA) have themselves established as a good risk hedge. They can position themselves on the highly liquid futures markets for both directions. The stronger an upward or downward trend forms, the more they can profit from it.

Opportunities
  • Hedging is recommended in the current challenging environment
  • Trend following systems (CTA) have been able to add value in previous bear markets
  • CTAs are more liquid, cheaper and more accurate than traditional hedge funds
Threats
  • Trend changes are usually detrimental to performance
  • Trend followers can stay put for months and then suddenly make big gains or losses
Cash
Cash Overview

Dollar suffers bout of weakness

After the publication of the June inflation data for the US, the dollar went on a slide. The euro briefly traded at levels above 1.12 against the greenback. The inflation rate fell to 3 % in June and the core inflation rate unexpectedly dropped significantly to 4.7 %. This puts the key interest rate above the inflation rate, making monetary policy restrictive. Although the US monetary authorities raised the key interest rate again by 25 basis points in July, this was probably the last time in this cycle. This means that Fed interest rate fantasies are a thing of the past, which led to a slump in the greenback. Conversely, the ECB is likely to decide on more interest rate steps. We therefore expect that the EUR/USD increase is not yet over and may reach the 1.15 range

Opportunities
  • The British pound benefits from higher policy rates and a lower interest rate differential vs. the USD
  • The EUR still has surprise potential
Threats
  • Geopolitical risks prevent appreciation of emerging market currencies
  • Turkish lira is still under the spell of politics