Brightening Outlook for Equity Markets – Navigating through Fears and Worries

  |   Geopolitics, Macro

Financial markets look ahead and discount future developments. Thus, equity markets reflect fears and worries well ahead of actual economic pains, recessionary troughs or corporate distress and defaults.

Managing the Fear & Greed Cycle

As we know, risk assets move in fear & greed cycles from fear, despair, capitulation, hope, relief, optimism to euphoria, in other words, from overshooting to undershooting in prices and valuations.
However, major bottoms in financial market cycles are typically marked by excessive pessimism and capitulation associated with a significant financial accident.

Favorable Geopolitical and Economic News

In recent days and weeks we have seen crucial and new geopolitical and economic developments favorable to the equity markets’ outlook:

  • Trump losing the US mid-term elections and as such his grip on the Republican Party allowing the US institutional framework and political middle-ground to emerge strengthened
  • peaking inflation momentum and supply-side pressures slowly but steadily receding
  • the Crypto FTX’s collapse and past speculative excesses and leveraged bets further squeezed
  • the USD topping as a positive factor for world trade and the emerging markets outlook
  • Russian miscalculations leading to military withdrawal from Kherson and its isolation as a Pariah state growing
  • peaceful transition of power in Brazil sending a positive signal to markets and a warning to autocratic rulers at large
  • China’s post-CCP Congress easing on COVID and set to re-engaging with the Global West at this week’s G20 meeting

Equities – Asset Class of Choice

We are firmly convinced that equities are the asset class of choice and the major beneficiaries of the next disinflationary cycle. Consequently, we now advocate a renewed and steady increase in risk exposures to global equity markets. Apart from long-term holdings in Western high quality multinational firms our equity favorites include the US and South East Asia geographically as well as asset managers and luxury & lifestyle in terms of sectors.

Central Banks Going to Overshoot

Central Banks, led by the FED, are determined to restore lost credibility and will continue with tightening monetary policy, prepared to overshoot. Don’t wait for the FED to pivot as this will only happen in a situation in which financial system stability is endangered. The FED will far more likely reduce tightening monetary policy in line with weakening economic and inflation data.

Short-term Surprises at the Height of Inflation

The short-term outlook for inflation and interest rates is difficult, indeed, as lagging economic indicators such as labor market data are still not decisively softening. In addition, the short-term projections for energy and food prices are dependent on unpredictable weather developments and erratic geopolitics.

Higher Interest Rates are Causing Significant Economic Pain and Casualties

Painful real economic effects of significantly higher interest rates are lagging and, as a result, the corporate sector remains on a downward trajectory. The 2023 economic outlook is dire and we would still stay away from corporate credits as we expect spreads to widen and default rates to rise – remain vigilant.

Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA