Signs of a turning point

Andrea Quapp, Investment Director for Multi Asset Class Solutions (MACS) Continental Europe, explains why we might be at a turning point macroeconomically, how a weakening of the US dollar would benefit emerging markets and the alternatives available in the field of indirect real estate investments in Switzerland.

16 January 2023

The foundation of our investment thesis is the reversal of the interest rate trend, undynamic economic growth momentum, low productivity and demographic change.

After 10 months of rising yields, higher inflation and central bank rate hikes, we believe a turning point is now emerging. First, we note that inflation is gradually easing in the US, Europe and the UK, with the US Federal Reserve (Fed) in particular talking about slowing inflation. This is positive for financial markets. Second, China's easing of zero Covid measures is welcome news for the stock market and Chinese economic growth. Although the economic figures in China still show recessionary tendencies, we expect the policy shift on pandemic control to usher in a recovery.

In our view, monetary easing is closer than many realise. The Fed is the most active and important central bank globally, and we think it is very flexible and will be careful not to make a second policy mistake. The Fed has long viewed rising inflation as a short-term phenomenon and underestimated both its extent and persistence. Therefore, we believe it will ensure it anticipates a slowdown in inflation in time.

Another key point of discussion is when the appreciation of the US dollar will stop. The strength of the dollar has been a key drag on emerging market economies in recent months, as well as on their attractiveness as investments. As soon as the dollar weakens, we believe we will see the beginning of a recovery in the emerging markets.

There is currently little awareness of recession risk in markets around the world. The regional impact of an economic downturn is not being considered for Europe, the US or Asia. However, in Continental Europe, high commodity prices are likely to have a major impact on consumer demand, in particular, and the economy in general.

The Organisation for Economic Co-operation and Development (OECD) remains optimistic about the global growth trend. According to its latest report, it expects an expansion of 2.7% for 2023. However, the origin of potential growth has shifted slightly, with India likely to contribute more to the expansion than China as the country remains a source of uncertainty.

How does this shape our asset allocation views?

This leads to us adopting a moderately positive view on equities as we believe the risk premium is at an attractive level. Equity prices have fallen faster than corporate earnings. However, we clearly differentiate by region: we are still negative on Europe and neutral to slightly positive on Swiss equities as companies struggle with earnings growth potential. On the other hand, we are positive on US and Asia equities, though less positive about China. Besides the development of the Covid pandemic, the risk remains that China could launch a Russian-style war of aggression in Taiwan. If the political situation between China and Taiwan eases substantially, we believe this could present opportunity.

Increasingly positive on fixed income

With regard to fixed income, we see potential in government bonds – especially in the US, as well as catastrophe bonds. Nevertheless, the cycle of interest rate increases is dragging on the European government bond market. In the Swiss franc bond segment, there is no longer a negative interest rate, which we think will attract buyers again in the medium term. At the moment, however, real interest rates are not yet sufficiently attractive, in our view.

Indirect real estate investments as an alternative

With the risk-free interest rate in the US at around 4%, we believe the arguments for investing in more sophisticated or illiquid alternative asset classes no longer apply. In this area, we prefer to focus on indirect real estate investments in Switzerland. After the significant price correction of around 15% for listed real estate funds, the attractiveness of this segment has improved, in our view. The premiums have come back significantly in some cases and are now around 14%, as at end of 2022. In this context, funds with residential properties show a higher price premium to intrinsic value than funds investing in commercial properties. However, the question is whether the funds have left the lows of mid-October behind them or whether a new slump will take place because investors fear that the Swiss economy will lose growth power. In our view, the tension between rising nominal yields and at most a constant payout ratio will remain for the foreseeable future.