The path to capital markets becomes more difficult with the announced Fed cut and risk factors such as China and the concerns surrounding the Chinese real estate group ‘Evergrande‘becomes a challenge.

In the equity segment, we are taking profits in Europe and the UK, and in bonds, selection remains decisive in all categories.

LGT Private Banking Europe View of the house

At the much-publicized Jackson Hole Federal Reserve Symposium at the end of August, the Fed Chairman Jerome Powell has already hinted that the US central bank will soon adjust its ultra-expansionary monetary policy and start what is called “tapering”, that is, reducing quantitative easing (QE). However, this does not mean that the Fed will reduce its balance sheet, but simply make less additional liquidity available to the capital markets. Investors now expect the Fed’s tapering process to begin in the coming weeks. This, however, is conditional on continued positive developments in the US economy. While the timing and predictable speed of the tapering were roughly expected, the Fed nonetheless surprised at its monetary policy meeting last week, claiming that an effective turnaround in interest rates, or a first rate hike , could be expected earlier. The Fed The roadmap calls for the Fed’s key rate to rise slowly to 2.5% by the end of this rate hike cycle. However, eight of the 16 members of the Federal Free Market Committee (FOMC) are already of the opinion that the Fed should depart from its near-zero interest rate policy as soon as December 2022. The bottom line is that the Fed’s current communication was a bit more “hawkish” than expected.

The road becomes more stony

As the Fed has set a new course, the path for capital markets is likely to get a little rockier, but not much more. Economic growth is expected to be above potential next year in both United States As well as inside Europe. Leading indicators in the G10 countries peaked over the summer, but continue to point to solid expansion, reinforcing our constructive core vision. Medium- to long-term inflation expectations in the United States are still far from the danger zone of 3% or more, ranging from 2% to 2.25%. Thus, the credibility of central banks, in the first place Federal Reserve, seems to remain intact.

Risk factors China and Evergrande

Risk factors for capital markets have actually declined in recent weeks. For example, the corona pandemic is now considered a “manageable” problem. However, a slowdown in the economic recovery in China, perhaps also because of the problems surrounding the Chinese real estate group ‘Evergrande, ‘could become a challenge in the short term. At least for now, a domino effect is not expected, as the investment grade segment in China reacted little to the fluctuations in high yield bonds triggered by Evergrande. Rather, it is a sudden cooling of from China real estate market, which is after all responsible for more than 15% from China economic return. As a result, some economists have already reduced their GDP estimates to China.

A delicate balance

For the Federal Reserve it will be a delicate balancing act to wean financial markets off quantitative easing and trigger the first interest rate hikes in less than 18 months. The Fed should aim to complete the tapering by summer 2022, i.e. to reduce the purchasing program compared to the current one $ 120 billion per month to zero. Although the effect of this process cannot be dismissed out of hand, we should, so to speak, leave the church in the village. On the one hand, the Fed’s monetary policy remains expansionary, and on the other hand, the financial markets continue to be supported by the QE programs of the European Central Bank and the Bank of Japan.

Equities and commodities remain in the portfolio

As we enter the final quarter, equities and commodities remain a priority and should be favored over bonds and liquidity. Despite increased volatility, investors will not be able to avoid stocks, in our view. The equity risk premium for the S&P 500 remains above 300 basis points and profit margins have never been higher in the past 40 years. However, the Fed’s tapering may well make it harder for financial markets. In early November, however, the seasonality should be historically favorable. We remain positive on commodities in the context of the portfolio as we believe prices in the current environment are driven by limited supply and less by demand.

Actions Europe and UK downgraded to “neutral”

In our equity strategy, we are degrading both Europe (ex-UK) and the UK to “neutral” to selectively achieve gains. The valuation discount of Europe in the US and the global stock market is no longer attractive enough to warrant an overweight in the short term. Across all assets, we continue to stick with a globally ‘dumbbell strategy’: on the one hand, we focus on growth companies that benefit from long-term trends such as digitization and, on the other hand, on quality cyclical businesses that benefit from global economic growth.

No experiences with fixed income securities

The example of ‘Evergrande‘shows once again that in the current environment, it makes little sense to take major risks on the interest rate side. Investors should take them on the equities side, if they so choose. With the start of the tapering process, the long end of the US yield curve should rise slightly to 1.75% over the 10-year range. We are maintaining our neutral position in duration. Within a bond portfolio, we continue to favor hybrid bonds as well as emerging market bonds in local currencies. However, selection in all categories remains crucial, as we have recently seen in the short-term market turmoil in China.

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Editor: LGT Bank (Switzerland) SA, Glarnischstrasse 36, CH-8027 Zurich

Author: Thomas wille, Research & Strategy Manager, Email: [email protected]

Editor: Alexandre fezzi, Email: [email protected]