The political dispute over raising the debt ceiling in the US has been at the centre of attention on the financial markets in recent weeks. With the agreement now reached to raise the debt ceiling for two years, which still has to be approved by parliament, the risk of a default by the world’s largest economy is off the table for the time being. As with the crisis of the US regional banks, this is a classic extreme risk ("tail risk") on which investors should not base either their medium-term strategy or their short-term positioning. We will continue to monitor the situation closely, but consistently focus on factors that allow us to make a forecast.
These include, of course, growth and inflation expectations in both developed and emerging markets. Growth remains weak, but inflation is likely to have peaked, so we expect the growth-inflation environment to stabilise and gradually improve in the coming months. On the positive side, the expected cycle of interest rate hikes is probably in its post-game phase, i.e. the surprise potential for even higher policy rates is extremely limited. This applies to expectations for both the Federal Reserve (Fed) and the European Central Bank (ECB).
In an environment where macroeconomic indicators are stabilising and tail risks are weighing on investors’ nerves, selection is increasingly important, not only within the equity allocation but also within the bond allocation. The current theme of our investment strategy is "know what you own." This, for example, is illustrated by the lagging performance of the S&P 500 compared to the DAX or the Nasdaq in the first five months of this year.
Companies on both sides of the Atlantic have positively surprised analysts’ low expectations. Strong nominal economic growth has boosted corporate sales but earnings growth remains close to zero. The real test is yet to come in the second quarter. But by late summer at the latest, capital market participants will already be looking ahead to 2024. The next two to three months are likely to be the hot phase for possible company-specific disappointments. At that point, the stock markets, as classic leading indicators, will already be looking ahead to next year.
The macroeconomic environment remains mixed between different regions. On the one hand the developed world, where the US is likely to head for zero growth or a mild recession in the second half of the year, and on the other the eurozone, where silver linings have emerged in recent weeks, and emerging markets, led by China, should be a guarantor for avoiding a global recession. What remains crucial is how quickly core inflation in the developed world declines to a level below 4% that allows central banks to regain their battered credibility.
While the macroeconomic environment is improving in relative terms, we cannot yet turn outright risk-on in absolute terms. Having added risk selectively in recent months - to emerging markets and European equities - the focus is now on differentiation within asset classes. In our view, this is the most important factor for success in the months ahead. We maintain our preference for alternatives and bonds over equities.
The recent earnings season has provided positive surprises, but not all questions have been answered. We therefore favour companies with attractive growth prospects and stable margins. We are sticking to our barbell strategy: On the one hand, our preference for "the rest of the world" (appreciation of emerging markets and Europe in recent months) over the US. On the other hand, we are focusing on themes such as artificial intelligence (AI) or reshoring, which have attractive potential in the medium- term. At sector level, we favour healthcare for its defensive characteristics and energy for its valuation. We also add consumer staples to our preferred sectors.
We are almost at the end (Fed) or in the last third (ECB) of the rate hike cycle of the major global central banks. This is also the reason why we tend to expect a steepening of the US yield curve. Short-duration bonds remain an attractive investment opportunity in our view. Within the credit segment, we clearly favour investment grade bonds over high yield, given the still weak economic environment in the developed world. At the same time, we remain neutral on emerging market debt.
Discussions about de-dollarisation and the rise of non-US dollar currencies have sparked debate. However, a closer look reveals a different reality. However, the arguments supporting these claims are often exaggerated. The incomplete nature of the EMU poses a significant hurdle for the euro to emerge as a genuine alternative, while the limitations of China’s currency and capital markets diminish the yuan’s viability. Data analysis and the continued dominance of the US dollar in global trade and financial transactions indicate that de-dollarisation is primarily a perceived rather than an imminent reality.
Gold remains an important building block in a multi-asset portfolio over the medium-term. Following this year’s rally, we would take advantage of periods of weakness to add further. Within the alternative allocation, we maintain our neutral position in commodities and insurance-linked bonds.