Investors should remain cautious as we are not at the start of a new bull market for risk assets, despite the S&P 500 now up two consecutive months for the first time this year.
Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate and currencies.
Confidence is returning. The dollar has sold off, as investors moved away from the most defensive asset classes. The VIX index of implied volatility in the S&P 500 over the coming month is at 20, a three-month low.
Last week’s lower than expected euro zone inflation figures confirms a global trend: weaker energy and services inflation is pulling down headline consumer price index (CPI) inflation rates.
As a result, market analysts are expecting reduced interest rate hikes this month from the Fed, the European Central Bank and the Bank of England of 50 basis points, or 0.50%.
The relief among investors is palpable, as is the sense the beginning of the end of the current interest rate cycle.
However, investors should remain cautious. While inflation has cooled, it is still way too hot for central banks to step down from their agendas of interest rate hikes just yet.
What we’ve been seeing over the last few days is a relief rally.
The past two years have been characterised by inflation being higher, and more resilient to interest rate hikes, than had been expected. This reflects its complex nature.
It has been a mix of supply-side issues such as high energy prices, COVID-related supply chain bottlenecks and labor shortages, along with strong demand, driven by government spending and the unwinding of pent-up savings.”
Declines in energy prices will do little to ease the shortage of manpower bedevilling the industrialised economies and contributing to rising wage growth. While inflation may be falling in the U.S and the euro zone, and will start falling in the U.K over the coming months, it is not going to be put back into its box with ease.
Federal Reserve Chairman Jerome Powell and the ECB President Christine Lagarde have both warned of the ongoing danger of wage-driven inflation arising from tight labor markets. The Bank of England shares the same concerns.
We may have seen, or be seeing, peak inflation but it is not until we see weakness in labor markets that headline inflation will reach the 2% target that is common to most major central banks.
To achieve that, interest rates may have to remain at peak levels for some time, and recession in the U.K and euro zone is a certainty. The U.S looks set to have the shallowest downturn, but may still record a recession.
The impact of weaker demand on corporate earnings does not appear to be fully priced in for U.S stocks, if official forecasts for the U.S economy are to be believed. For example, the S&P 500 index ended November on a forward price/earnings (P/E) ratio of 19. This means investors are willing to pay the equivalent of 19 years of company earnings to own a share in the company.
This is lower than the 22 P/E ratio of a year ago, suggesting a more cautious approach by investors to expected corporate earnings growth. But the Conference Board outlook for U.S economic growth is very different from what it was a year ago. Its estimates are for GDP growth to be 1.8% over calendar 2022, and zero next year. U.S exporters will, meanwhile, be selling into still tepid European markets.
Government bonds may rally on a scenario of weak growth/recession and rising unemployment, and this is the area potentially of most interest over the coming months.
However investors should be wary of trying to time market cycles, and instead adopt a more cautious approach by investing in a full range of assets that will rise at different points in the economic cycle.
London-born Nigel Green is founder and CEO of deVere Group. Following in his father’s footstep, he entered the financial services industry as a young adult. After working in the sector for 15 years in London, he subsequently spent several years operating within the international space, before launching deVere in 2002 with a single office in Hong Kong. Today, deVere is one of the world’s largest independent financial advisory organizations, doing business in 100 countries and with more than $12bn under advisement. It specializes global financial solutions to international, local mass affluent, and high-net-worth clients. In early 2017, it was announced that deVere would launch its own private bank. In addition, deVere also confirmed it has received its own investment banking license.
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