In the LGT Private Banking Europe Midyear Outlook (June 23, 2021), we highlighted an imminent adjustment in the monetary policy of the US Federal Reserve and thus an abatement of the enormous flood of central bank liquidity as one of the major challenges. This important change, or more precisely the announcement of a future adjustment, was communicated by the Fed in June. To date, the Federal Open Market Committee (FOMC) of the Federal Reserve had held out the prospect of a first interest rate step in the first quarter of 2024. Now this date has been brought forward to the second half of 2023. We would not be surprised if this guidance was even pushed into the first half of 2023 in the coming months. For now, capital markets are assuming an initial interest rate hike in the United States of 25 basis points in the fourth quarter of 2022, which would also index that the Fed is behind the curve. However, we stand by our assessment that the Fed will not raise key interest rates this year or next, while at the same time providing financial markets with significantly less liquidity.
Overall, central bank monetary policy remains expansionary, even after the Federal Reserve's cautious announcement, because we are talking about possible changes in one and a half to two years. Nevertheless, the adjustment in the Fed's communication will probably cause further unrest and partly headwinds in the coming weeks, especially for asset classes that have moved away strongly from their long-term valuation levels. This is also the reason why we are now positioning ourselves a “touch” more defensively on the equity side.
The eurozone has started the widespread vaccination campaign against the Covid-19 pandemic later than the US and therefore still has catch-up potential. However, the latest economic data from continental Europe should continue to positively exceed analysts' high expectations. For example, Germany's widely followed Ifo business climate index continued to rise in June, both in terms of expectations and current assessments. In contrast to the Fed, we expect the European Central Bank (ECB) to maintain its expansionary stance for much longer and not to turn the interest rate screw in the foreseeable future. On the one hand, this is in order not to jeopardize the economic recovery in the periphery and, on the other hand, to ensure that the tender “little plant of inflation” flourishes.
At a time, frame of six to nine months, capital markets are usually a good leading indicator. Since June 22, the longest day in the northern hemisphere is already behind us again and the days are starting to get shorter. Of course, we are just enjoying the summertime, yet in four to six months the flu season will probably start again and with it the challenges to control the pandemic. The Covid-19 vaccines are having an effect, but major events such as the EURO 2020 show that there is still a long way to go to normality as we knew it before the corona crisis. Therefore, in our view, a renewed pandemic wave in the fourth quarter remains a risk factor that should not be underestimated, especially regarding the delta mutation.
In the coming weeks, the Federal Reserve's rhetoric adjustment is likely to have an impact on positioning as well as further developments in capital markets. Despite the now earlier anticipated turnaround in interest rates, we see the most potential in equities and commodities at the asset allocation level now. This also leads us to adhere to our previous two convictions: On the one hand, we prefer equities over fixed income and, on the other hand, we like commodities over liquidity.
On an absolute level, valuations of global equity markets remain in the top quartile by historical standards. However, positive earnings revisions of analysts, which again increased strongly in June, are supporting large parts of the markets. As we enter the third quarter, Europe remains the “place to be” at the country level, as both easing pandemic restriction and reopening trends and relative valuations favor the region. Emerging market companies also have potential, in our view, and we expect Chinese equities to be in a bottoming phase. At the sector level, we would like to highlight the non-cyclical consumer sector, as it has a historically low valuation relative to the overall market on the one hand, and is a stable pillar in the portfolio in turbulent times on the other.
With the enormously low interest rates on government bonds and record low credit spreads on corporate bonds as well as high yield bonds, it remains a challenge for investors to still find attractive areas. For hybrid bonds, we remain confident and prefer CoCo's as well as Corporate Hybrids due to the attractive spread level in historical comparison. We have also upgraded emerging market bonds in local currency from “neutral” to “attractive”. The focus is here on the improving growth prospects for emerging markets as well as the high carry of more than 400 basis points in the US dollar and even 550 basis points in the euro. In all fixed income areas, we recommend keeping duration short in the coming months.
After the recent price correction, gold has potential again in our view and should be a safe anchor across assets, especially in turbulent and uncertain times. Of course, timing should not be underestimated here either, but we expect clearly higher gold prices in the coming quarters than at the beginning of the second half of the year.
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Head Research & Strategy, Email: email@example.com
Editor: Alessandro Fezzi, E-Mail: firstname.lastname@example.org
Source: LGT Bank (Switzerland) Ltd.
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