Any rate cut fantasies seem to have fizzled out and investors have a more realistic view of the Federal Reserve's rate path again. Within the equity quota, we recommend a defensive positioning and prefer the "rest of the world" to the US. After the correction, we are raising gold in the portfolio from "neutral" to "overweight" at the expense of the liquidity ratio.
Central banks of the Western world will remain the dominant factor on capital markets in the coming weeks, first and foremost of course the Federal Reserve (Fed). Not only the effectively implemented interest rate hikes - the Fed last raised its key rate in February by 25 basis points to the current target range of 4.5-4.75% -, but also the open communication of the members of the Federal Open Market Committee (FOMC) play a role. Of course, Chairman Jerome Powell's word carries the most weight. However, the financial media are meticulously dissecting every statement made by individual governors.
In our view, the Fed's starting position has changed little in recent weeks. The focus remains the fight against inflation and thus the restoration of price stability at any price - even if this battle results in a recession. In this sense, the Federal Reserve has not yet reached its goal. The hopes for an easing of key interest rates, or a so-called "pivot", that have repeatedly been raised seem premature now. Currently, investors are even expecting an additional interest rate step, which would raise the Fed's key rate to a “terminal rate” of 5.25-5.5%. However, we do not consider this minimal change in expectations to be significant. In our view, it is much more important that any rate cut fantasies for this year have fizzled out and investors have a more realistic view regarding the US central bank’s future monetary policy path.
Since October 2022, we have seen a solid recovery in the equity markets. What is most striking here is that US equities have lagged emerging markets or European stocks by almost 10%. The "rest of the world" has been able to outpace the US in recent months due to cheaper valuations and a lower share of technology stocks. But now we are facing weeks of truth. This will show whether the stock market has been just another bear market rally in recent months or whether we are in a new sideways trend. The former is supported by the valuation - especially of US equities - and the continuing restrictive monetary policy of most important central banks. In favour of the second is the fact that market breadth has improved, and various stock indices are above the important 200-day average. As an investor, one has the option to wait and see, as there are attractive alternatives such as short-term bonds in today's market environment. With the end of seasonality and the permanent headwind from monetary policy, we are anticipating a rather difficult market environment in the coming weeks.
In the current environment, we maintain our short-term preference for bonds over equities. In particular, the equity risk premium in the US is not attractive enough to build up broad positions. The earnings yield of the S&P 500 is only slightly above the yield of two-year US government bonds and, in our opinion, impressively shows that there is currently no pressure to build up risk in the portfolio. Across assets, bonds remain "overweight" and equities "underweight." After the correction, we increase gold from "neutral" to "overweight" in the portfolio at the expense of the liquidity ratio, which we reduce from "overweight" to "neutral."
Although the US has not yet experienced an earnings recession, earnings revisions remain negative. Persistently high inflationary pressures are likely to continue to challenge corporate margins in the first and second quarters of 2023. Within the equity allocation, we continue to recommend a defensive positioning and have a preference for the “rest of the world” over the US. At the sector level, we favour financial stocks and the pharma sector. At the same time, we remain cautiously positioned with respect to technology stocks and the consumer cyclical sector.
We expect further interest rate hikes from both the Fed and the European Central Bank (ECB). Therefore, we consider it too early to increase or extend the duration in the portfolios. We consider the short-term bond segment attractive, for government as well as corporate bonds. In the credit segment, we have a clear preference for investment grade over high yield.
As mentioned, we have raised our assessment on gold from "neutral" to "overweight," as we do not expect real interest rates in the United States to rise further. Within the alternative Investment segment, we also prefer hedge funds over insurance-linked bonds (ILS), REITs as well as listed private equity.