Is the rally in global equity markets just a bear market rally or something more fundamental? It’s likely that investors believe that they know how the coming slowdown will look - and crucially, its eventual recovery. A word of warning: over confidence in the ability to assess the impact of monetary policies and future economic scenarios could be detrimental.
Why did equities rally?
The rally in global equity markets surprised many. Fears of a coordinated recession in the US and Europe coupled with a sharp slowdown in China were high. Lockdowns combined with a real estate crisis left many to worry about the Chinese market. As a consequence, investor sentiment reached extreme bearish levels and few market participants thought of it this time as a good counter-indicator signal.
Eventually, equities rallied from their June/July lows led by the US and Tech. US consumer demand and the labour market were more robust than expected, while earnings surprised on the upside. Fear of natural gas shortage in Europe over the winter subsided somewhat.
Investor sentiment remained depressed in China amid signs of a cautious fiscal and monetary expansion. The reason lies in the excessive debt on the balance sheet of provincial governments and their potential projects are less appealing than they used to be. In a sense, China has done the bulk of the heavy infrastructure investments it needs for the coming decade or so.
The outlook
Fear of persistent inflation for the Fed and ECB have now given the equity market a pause. The market is left to oscillate between hope of less conservative monetary policies and concerns that the economy is indeed slowing down.
Demand is holding well from mid and top tier consumers driven by market gains and a tight labour market. This should lead the Federal Reserve to tighten monetary policy somewhat faster than is currently expected.
The peak in Fed funds is predicted to be at 3.7% in April 2023; the odds are that we will get there much faster through 50/75bp rate hikes followed by a long pause as the Fed assesses the impact of its tightening and the anti-inflationary fiscal package. This represents opportunities to build long equity positions at less expensive levels.
European central banks are behind the curve and the ECB’s Schnabel now points the way to a 50bp rate hike in September as the ECB continues its hawkish turn. Solid real estate, equity gains and a robust labour market should support consumption in Europe.
What does it mean for investors?
These upcoming shocks from tighter monetary policy should create entry points for companies that are both cheap and offer a quality of cash flows, listed infrastructure, ESG and real estate. We note two major issues: in passive indices, namely a high concentration risk with Apple; and the risk of an Iran deal which would send oil prices significantly lower.
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