As the end of 2022 approaches, various encouraging elements have disrupted the prevailing gloomy outlook: China has started easing its zero-Covid policy, the global economy may be decelerating but is less depressed than expected, gas prices everywhere have fallen sharply and inventories look high enough to get us through winter. Above all, there are incipient indications that US inflation is turning lower.
We could also point out that the idea of peace talks has been mooted in the Kremlin following the Russian army's retreat from Kherson. Press reports even suggest the West and Ukraine itself might be on the same wavelength albeit more discreetly. We should avoid rushing to conclusions but there is an air of change about. Equity and bond markets have reacted by rallying sharply since October.
Slowing US inflation is reassuring
There is no doubt that the decisive issue is whether US inflation turns lower. The surge in inflation started in the US and has had the biggest impact on markets this year. It goes without saying that a small drop does not constitute a trend but it is reassuring that the slowdown in inflation has been seen in goods and services generally and not just in isolated components. As commodity and freight prices have been returning to normal and production lines are back in action, it is only logical to see a slowdown in goods inflation. And with falling property prices and the sharp drop in new rents, we can also expect the rent index to slow over the second half of this year. Despite all this, inflation will struggle to move below 4% if wages continue to rise by around 5%. The labour market is still very tight. The Fed will be forced to keep a very close eye on employment data but it would be a whole new game if inflation were to fall back to more reasonable levels. That is not yet a done deal but it would mark the end of persistent upward revisions in the Fed Funds rate, reduce bond market volatility from extreme levels and therefore volatility on all markets.
Recession is still a possibility
At the end of September, we were still cautious on equities, saving ammunition for more tactical moves. We have since gradually raised equity exposure towards neutral. Faced with today's situation, we are sticking to this stance for a little longer while staying tactical. Equity markets have already enjoyed a strong rally but a recession is still possible. The global economy is still slowing and company margins continue to contract. This leaves us with poor visibility on equity markets but they could still continue to rise up to the end of year, especially if we have more signs of disinflation.
If US inflation has already peaked, the dollar should stabilise as the interest rate differential between the US and elsewhere would logically narrow. We now think it is time to raise exposure to emerging country debt, a segment that would benefit if the Fed pivots, the dollar stabilises and China’s zero-Covid policy eases. We are also raising portfolio duration with US Treasuries and investment grade corporate debt while staying somewhat cautious on European duration. Markets are already expecting the ECB to raise rates a little above 2.75%, but high inflation in Europe and poor visibility on the ECB’s policy suggest we should tread more carefully.
Key Points
- We are raising exposure to emerging country debt
- We are increasing portfolio duration with US Treasuries and investment grade corporate debt'
- We remain somewhat cautious on European duration
LEGAL DISCLAIMER : Written on 14/11/2022. This document is issued by Edmond de Rothschild Asset Management (France). This document is non-binding and its content is exclusively for information purpose. Any reproduction, disclosure or dissemination of this material in whole or in part without prior consent from the Edmond de Rothschild Group is strictly prohibited. The information provided in this document should not be considered as an offer, an inducement, or solicitation to deal, by anyone in any jurisdiction where it would be unlawful or where the person providing it is not qualified to do so. It is not intended to constitute, and should not be construed as investment, legal, or tax advice, nor as a recommendation to buy, sell or continue to hold any investment. EdRAM shall incur no liability for any investment decisions based on this document. This document has not been reviewed or approved by any regulator in any jurisdiction. The figures, comments, forward looking statements and elements provided in this document reflect the opinion of EdRAM on market trends based on economic data and information available as of today. They may no longer be relevant when investors read this document. In addition, EdRAM shall assume no liability for the quality or accuracy of information / economic data provided by third parties. Past performance and past volatility are not reliable indicators for future performance and future volatility. Performance may vary over time and be independently affected by, inter alia, changes in exchange rates. « Edmond de Rothschild Asset Management » or « EdRAM » refers to the Asset Management division of the Edmond de Rothschild Group. In addition, it is the commercial name of the asset management entities of the Edmond de Rothschild Group.
Edmond de Rothschild Asset Management (France)
47, rue du Faubourg Saint-Honoré, 75401 Paris Cedex 08
Société anonyme governed by an executive board and a supervisory board with capital of €11,033,769 -
AMF registration No. GP 04000015 - 332.652.536 R.C.S Paris