Commentary, 17 of July 2024
After an outstanding first half-year for equity investors, the question for the next six months is whether things can continue in this vein. While there are clear signs of a bubble forming in the form of excessive price rises coupled with historically record-high P/E ratios, particularly for US large cap technology stocks, the significantly more favourable valuations of companies from other sectors give cause for optimism. As the price performance of most technology shares is essentially based on real substance in the form of sales and earnings growth, there is also justified hope that there may actually be positive spillover effects on companies from the rest of the economy. This is because as long as the economy does not fall into recession, the negative profit effects for company shares due to weaker economic activity are likely to be more than offset by positive valuation effects from expected interest rate cuts.
Of course, the latter assumes a continued downward trend in inflation rates, for which there are good reasons. For this sector rotation to run smoothly, equity market investors must be willing to adjust a momentum trade that has been outstanding since the beginning of 2023 with regard to a broader equity market allocation. A moderate, non-disruptive price correction in the most important technology equity indices is a crucial prerequisite for this. In short, a merely gradual adjustment of existing equity market positioning would help. The recent price gains in small cap indices (MSCI World Small Cap, Russell 2000) are certainly positive in this respect. Increased expectations of a victory for D. Trump in the US presidential elections should provide an additional tailwind.
Bond investors should continue to position themselves neutrally in this scenario. This is supported on the one hand by the already comparatively low yield premiums for IG and HY corporate bonds, and on the other hand by the lack of interest rate fantasies with regard to far-reaching interest rate cuts by the most important Western central banks. Short-dated securities also have the advantage of lower interest rate volatility in the event of unfavourable (geo-)political events. At the same time, default rates remain within moderate ranges. Purchases focussed on duration should therefore be made selectively during periods of stress. After many years of zero interest rate policy, attractive securities with high coupon payments are now available again across the entire bond spectrum, which can significantly dampen short-term fluctuations in value. Government bonds should continue to be treated with caution due to the consistently high refinancing requirements and considerable new issuance activity as a result of high budget deficits. Both the USA and the eurozone lack credible consolidation measures in this regard. Emerging market bonds in hard currency offer advantages in this respect, and the recent development of Brazilian public finances once again demonstrates the need for a correspondingly selective allocation.
Even in the current interest rate environment and as in the past year, alternative investments, especially commodities, are an important addition and should remain overweighted. On the one hand for reasons of inflation protection and on the other hand against idiosyncratic risks. Gold in particular plays a central role in this context, as potentially negative spillovers from military conflicts (Ukraine/Russia, Israel/Palestine and China/Taiwan) are still very high, even apart from systemic risks. However, the global financial markets have already shown themselves to be remarkably resilient in the face of high uncertainty caused by geopolitical tensions and economic uncertainties in the past. This high level of resilience, particularly in the equity markets, is another positive argument in favour of investing in risky forms of investment.
Mag. Manuel Schuster, IMC
CEO&CIO, FAME Investments AG