- We are entering a tough phase of the regime shift, as the risks over economic growth add to the already hot inflationary backdrop. This means that stagflation fears will continue to drive the market and risk assets are likely to remain very volatile, particularly the most indebted companies and those with still excessive valuations.
- Central banks have now acknowledged the inflation problem and changed their tone. They seem ready to act to protect their credibility, at least temporarily. However, they will probably not go too far and markets have already moved to incorporate their hawkishness. The extraordinary ECB meeting is a case in point of a central bank struggling to provide the market with a clear monetary compass and framework in a regime shift. In fixed income this calls for a neutral duration stance and a focus on quality credit and liquidity.
- In DM equities we remain cautious as the earnings outlook is still too optimistic, in our view, and the risk is to the downside. The current repricing is taking most of the overvaluation out of the market, but current levels are vulnerable to any deterioration in corporate fundamentals. Companies’ earnings resilience and pricing power will be key drivers of the great discrimination in equity markets. Our forecast of a possible earnings recession in the EU leads us to maintain a more careful stance on Europe and supports our preference for US vs. EU equity.
- Regionally, we find Chinese equities more attractive as these are more insulated from the current turmoil emanating from the developed world. They should also benefit from the reopening of the Chinese economy, as well as the country’s lack of inflationary pressure and current policy support.
Dramatic price action has taken place over the past few days, following last Friday’s hot US inflation print of 8.6% YoY, a new 40-year high and an unexpected acceleration.
The US equity market has dropped almost 7% MTD, bringing the total YTD performance for the S&P 500 index to -21%, meaning it has officially entered a bear market phase. Bonds have been equally shaken as 10-year Treasury yields rose to above 3.3%, a level not seen since 2011.
In Europe a surge in bond yields followed the hawkish stance at the last ECB meeting, driving European equities to their lowest levels since March 2021 and Italian BTP yields to above 4% for the first time since the end of 2013. This prompted the ECB to announce an emergency meeting to tackle the market sell-off and avoid any fragmentation risk in the financial markets.