Like a sweltering summer afternoon, where a storm sometimes bursts without triggering a change in the weather, capital markets have experienced turbulence this summer. Despite the rapid recovery after the sharp market decline in August, the imbalances that contribute to market fragility have not been resolved. With the exception of technology stocks, valuations appear reasonable. However, they will only be so if high profit expectations are met. If signs of an economic slowdown become clearer, volatility could quickly increase again, as we observed in early September. The nervous market atmosphere is expected to continue into the fall.
By Laurent Denize, Co-CIO ODDO BHF and CIO ODDO BHF Asset Management
Soft landing, disinflation, lower interest rates and politics
A slowdown in growth, not a recession, is expected over the next four months. According to Denize, major economies are recalibrating after the phase of aggressive monetary policy. Although consumer demand has fallen slightly, there remains enough momentum to avoid a contraction. Inflation, which until recently was the main concern for global markets, appears to be under control and many central banks have opted for easing. This movement is favored by the slowdown in the labor market. Investors should prepare for this change in monetary policy stance, as it could have a significant impact on bond markets, financing costs and capital allocation strategies. Lower interest rates are historically good for equity markets because they stimulate borrowing and investment. The political context makes market dynamics even more complex. In the event of Trump’s electoral victory, the risks would be higher (trade conflicts, inflationary measures, attacks on the independence of the Fed, etc.) In Europe, the lines of political conflict within the euro zone constitute a challenge, and in the Middle East, geopolitical tensions remain a permanent risk. According to Denize, investors should follow these developments closely, as geopolitical shocks can quickly shake economic stability and trigger sharp market corrections.
Three levers: rotation, duration, carry
The prospect of falling interest rates makes money market investments less and less attractive. Investors should now consider how to make their money grow in a volatile market. In his current explanations of investment strategy, three tactical strategies are offered here:
1. rotation: rebalancing between sectors and assets
With the start of the decline in interest rates, a new cycle is emerging, offering opportunities for reallocation towards more defensive sectors. The real estate, construction, consumer staples and utilities sectors have performed strongly in the past due to their sensitivity to interest rates. These sectors are worth considering for investors looking to take advantage of falling interest rates. There are also good opportunities in the UK, particularly in small and mid caps.
2. duration: management of interest rate sensitivity
Duration measures a bond’s sensitivity to changes in interest rates. Government bonds have already priced in most of the interest rate cuts – 10-year federal bonds today yield 2%. Investors should instead look to corporate bonds which still offer a reasonable premium.
3. carry: optimization of yield in a context of falling interest rates
By investing in higher-yielding assets, like corporate bonds, investors can earn returns that allow them to offset potential volatility in other parts of the portfolio. According to ODDO BHF, investment grade bonds currently offer better return prospects than government bonds and are expected to perform well even in an unfavorable economic environment. High yield bonds continue to benefit from historically low default rates and have sufficient buffer to withstand a sharp rise in risk premia. Short maturities offer the greatest potential.
Volatility as an opportunity
What if turbulence occurs? The market collapse in August should be a reminder of how quickly conditions can change. Currency developments should therefore be closely monitored, as further liquidation of carry trades could trigger further volatility and push exchange rates higher. Phases of increased volatility are inevitable in the coming months, but they also offer the opportunity to enter long-term growth themes at more attractive valuations. We can remain positive on stocks. Our focus remains unchanged: Artificial intelligence (AI) and green transformation continue to offer long-term exponential growth potential.
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