Investment Outlook February 2023

The year has been off to a good start: Inflation is coming down, the markets are up accordingly. The big question in this situation is: what does the central bankers think about these developments?

In our view, the central banks will take those indicators with a grain of salt: Inflation is coming down, but nowhere near their mandated targets. Unemployment is rising, but still below what most countries consider as their natural rates. This in turn leads us to be cautious about the current market rally, as there could still be significant downside potential. Until we see clear economic signs that the bear market is coming to an end and central bankers are ready for the much talked about pivot, we keep our conservative stance both in equity and bond markets.

So our message to our investors remains: don’t panic, but stay cautious.

BENDURA market views

The terms attractive / unattractive describe the return potential of the various asset classes. An asset class is considered attractive if its expected return is above the local cash rate. It is considered unattractive if the expected return is negative. Very attractive / very unattractive denote the highest conviction views of the BENDURA Investment Committee. The time horizon for these views is 3-6 months.

Global Economy

As mentioned in the beginning, the question remains: how will central banks react to the current economic developments? When we look at the FED, their dual mandate is to keep inflation at 2% while also maximizing employment. The 2% is clear, with unemployment it is estimated that they target a 4% rate. So, to bring this into perspective, the PCE hovers currently around 5% while unemployment is still at 3.5%. Therefore, they are still missing their inflation target but have room on the unemployment side. Considering the slow pace with which inflation is coming down, it is hard to rationalize why the FED should go for a pivot now, which could premature and tip the tide of inflation back into rising territory.

But it is more complicated: While GDP has been robust lately, final sales to end consumers has clearly gone down, so has manufacturing activity. At the same time, the labour market remains tight, so unemployment remains low, which is bad news for equities, which perform best when unemployment is high (see Chart below).

This can only worry the central bankers, since a tight labour market coupled with core inflation rising (core inflation being heavily dependent on wages) are the perfect material for a price-wage spiral.

Equities

Having said that, equity markets boomed in early 2023. Especially European markets have outperformed, which normally only happens in the beginning of an economic expansion, since Europe is a cyclical market. This makes us even more cautious, as we think investors prematurely price-in an economic rebound, which goes against our expectations regarding interest rate cuts.

Also Emerging Markets had a good performance, profiting from China’s reopening. But this is a highly cyclical market as well, so we do not change our stance here either.

In general, we still prefer defensive sectors such as health care and consumer staples over cyclical ones.

Fixed Income

As with equities, our fixed income view also heavily depends on what central banks are most likely to do. Considering what we wrote above, central banks are unlikely to cut rates (rather we expect more moderate hikes and then a stagnation), we think that prices could come down a little more before going up again. So we remain neutral in the government bond segment.

On the corporate side, we see credit conditions deteriorating, valuations at their long-run average and the high yield segment not pricing in defaults as would be expected during a recession.

Therefore, we do not change to a more aggressive stance in the fixed income segment yet.

Commodities and Currencies

While the reopening of China should be good news for consumer markets and tourism, it is unlikely to significantly change the course of industrial metals, as we do not expect a rebound in infrastructure spending. The property markets remain dysfunctional and credit impulses are unlikely to target the segment heavily and change that.

The copper market for example has already priced in the better news from China, and oil will also likely rebound as a consequence of the reopening. Our outlook for 2023 is that Brent Crude Oil will reach 120 USD this year.

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