Asset Allocation

Notes from the Investment Committee

Equity markets started off the new year euphorically, and investors also resumed earning money with bonds in the first weeks of 2023. Conventional interest-bearing securities are now offering attractive yields again, and investors are no longer forced to resort to less liquid and/or more complex interest-bearing alternatives for yield.

Asset Allocation Monitor

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Currencies

Equities: Strong January

• Equity markets started off the new year euphorically. European stocks and emerging markets in particular registered big share-price gains north of 10% in some instances. Reduced risks of a recession in Europe, a drop in energy prices and the reopening of China’s economy drove the robust start to the year. So, as the new year gets into full swing, the scenario that we outlined in our outlook for 2023 – one in which equity bears get caught on the wrong foot in the first half and can’t get the cheap stock purchase prices they were hoping for – appears to be unfolding. However, in the wake of the rally of the past weeks, it has to be noted that the near-term risk/reward tradeoff is now neutral at best. Further swift share-price gains are unlikely. From a technical analysis perspective, a sustained breakout by the S&P 500 out of its downtrend channel would be desirable to confirm a medium-term trend reversal on the US bellwether market. But even if that happens, the performance of equity markets over the further course of this year is unlikely to be a one-way street.

• The outlook for corporate profit margins and earnings urges a certain degree of caution. Many companies opportunistically exploited the rampant inflation during the past several quarters to raise prices. This propelled profit margins to new all-time highs. Now, however, disinflation looks set to become the dominant topic in the months ahead. Corporate pricing power will likely suffer as a result, and this is bound to put downward pressure on profit margins. We see further downward potential for analysts’ earnings estimates despite the correction to a certain degree in recent weeks. Even in the best-case economic activity scenario (with no recession), corporate earnings look set to pull back by around 15% from their peak. In the ongoing reporting season for the fourth quarter of 2022, the overwhelming majority of companies thus far have issued guarded guidance for the remainder of this year.

Fixed income: Focus on liquid assets

• Investors also resumed earning money with bonds in the first weeks of 2023. Although central banks have stuck to their restrictive monetary-policy course to date, yields on long-term bonds have recently pulled back some more, further steepening the inversion of yield curves. This inversion is observable by now even at the very short end of the curve: in the USA, the yield on 2-year Treasury notes dropped below the federal funds rate. In the past, this consistently marked the end of the Federal Reserve rate-hiking cycle and presaged an imminent recession. If that’s the case again this time around, government bonds appear destined to continue performing well this year. If a recession doesn’t come to pass, bonds are likely to deliver a solid, albeit less spectacular, performance on the back of the expected disinflation in the months ahead.

• Since conventional government and corporate bonds have now resumed offering an attractive yield, investors are no longer forced to resort to less liquid and/or more complex interest-bearing alternatives for yield. The sea change in interest rates causes niche assets like microfinance bonds, for example, to lose attractiveness. We are downgrading our tactical stance on this asset class and are making corresponding adjustments to portfolios. Although insurance-linked bonds likewise belong to the “interest-bearing alternatives” category, they remain interesting this year in view of their substantially increased risk premiums and variable interest rates.

Alternative assets: Sparkling start to the year for gold

• US dollar weakness combined with falling real interest rates propelled the price of gold to a rocketlike start into 2023. The price of the precious metal has jumped 20% since November of last year. Its upward momentum looks set to ebb, though, at the psychological and technical resistance barrier

The gold price was given a rocket start into the investment year 2023

Higher construction costs and poorer financing conditions are putting pressure on price levels in more and more countries and real estate segments at the USD 2,000-per-ounce level, if not before then. However, looking ahead to the full year, gold remains a sensible asset to blend into portfolios in a variety of macroeconomic scenarios.

• The continually tightening interest-rate environment has dimmed the near-term outlook for real estate markets. An increase in construction costs and costlier financing conditions are pushing property prices down in more and more countries and real estate segments. This has also recently been reflected (with a time lag) in the share prices of unlisted real estate funds. Investors should exercise restraint with regard to real estate investments in the months ahead. We accordingly have downgraded this asset class in our tactical asset allocation. Semi-liquid real estate products in particular could remain under pressure for the time being (see the article in the “Drawdown: All about private banking” section).

Currencies: Is the euro poised to take a breather?

• EUR/USD: While macroeconomic data for the Eurozone have continued to surprise on the upside lately, they have come in on the disappointing side in the USA. A divergence in favor of the euro is also shaping up on the monetary-policy front. The European Central Bank is sticking with its hawkish rhetoric and envisages further interest-rate hikes while the US Federal Reserve is approaching the end of its rate-hiking cycle. However, in the wake of the recent rally, the euro’s comeback now gradually appears to be reaching the end of the road, as evidenced also by investors’ frothy speculative net long positioning in the euro.

• GBP/USD: The British pound also gained ground against the US dollar in January, though that was mainly due to pronounced dollar weakness. The UK’s fundamentals, in fact, remain very dismal.

US stocks outperformed the rest of the world for more than a decade. European investors with a high home bias often looked westward with envy. The recipe behind US stocks’ dominance was low interest rates, surging corporate earnings (particularly in the technology sector) and a strong US dollar. But every trend eventually comes to an end – the underlying fundamentals flipped last year, enabling mainly European and emerging-market stocks to regain significant ground since autumn. The MSCI World index excluding the USA overcame its long-term downtrend line. The reopening of China’s economy after the rollback of the country’s zero-COVID policy, cheap(er) stock valuations and the downturn in the price of the overvalued US dollar are some arguments suggesting that the current trend reversal is sustainable. This makes it all the more important right now for investors to check if their portfolios have excessive exposure to US stocks.

Among the world’s industrialized countries, the UK is the one facing the greatest risk of a recession and inflation. The Bank of England will hardly be able to raise its policy rate enough to retore the pound’s attractiveness for investors.

• EUR/CHF: The EUR/CHF exchange rate has climbed back above parity in recent weeks on the back of the abated risk of a recession in the Eurozone and the prospect of a widening interest-rate differential in favor of the euro. Another interest-hike by the Swiss National Bank in March might already be the last one, but the ECB is likely to keep on raising rates afterwards. If the “europhoria” continues, the value of the euro could conceivably climb to as high as 1.05 against the franc during the course of this year, but the franc’s long-term strength is undebatable, in our view.

Chart in the Spotlight

The end of the US bull market? – It’s the rest of the world’s time now MSCI USA vs. MSCI World ex-USA

Sources: Bloomberg, Kaiser Partner Privatbank