Financial market outlook has weakened over the course of the last few weeks; inflation remains stubbornly high, higher capital costs are impacting future growth rates, ongoing zero-COVID strategies remain key for some regions, and some political missteps, as occurred in the UK, add an additional layer of discomfort into the market. While the longer-term outlook remains valid, one cannot disregard the eventuality of a further market correction.
While a strong labor market is by definition a good mark, in today’s economic conditions this will translate into inflation pressure. With the latter being at 6.6% year-over-year in September, which is the strongest price growth since 1982, we are far away from a lower rate inflation as wage related is still to come. Therefore, the FED is expect3ed to finish hiking rates around 2nd quarter 2023, with the federal funds being around 4.75%
For corporation there are going to be some challenging circumstances such as weaker demand, rising labor costs, and rising input prices. As of now, global earnings growth in 2023 is expected to be below 5%.
On a relative basis and even with increased market risk and volatility, equity markets have not become cheaper relative to fixed income opportunities. The equity risk premium is almost at an equal level compared to beginning of the year.
Asset classes opportunities
Equities
Global equity market valuations are still hovering around long-term averages. Bearing in mind that markets are skewed to the negative, it is opportune to mitigate market risk instead of forgoing upside strategies that can play out once conditions return to some normality. Given this, interest rate sensitive sectors such as Technology, which suffer from the “decoupling” between the US and China, are a no-go for the time being. Healthcare and Consumer Staples remain two key sectors where pricing power can play out in favor of the investor.
Bonds
In an environment of tightening liquidity, yield sensitive instruments such as High Yield credit are at risk while more resilient Investment Grade credit still offers some opportunities.
Commodities
With the economic outlook being tuned negatively, the broad commodity demand will probably lower. The exception to this is energy related output; with supply-side related bottlenecks being in place for longer, one can expect the barrel price to remain skewed positively.
Uncorrelated market opportunities
Almost no asset class has been able to escape over a longer period of time market corrections. Carbon Notes are, as of today, the only investment opportunity that offer capital protection with a guaranteed coupon payment. Carbon Notes can be acquired via the EU Emissions Trading System (EU ETS).
EU ETS is a cap-and-trade system launched in 2005 that aims to reduce emissions by putting a price on CO2 and some other greenhouse gases (GHG) emissions. The EU ETS applies to any industrial activity. Each certificate gives the holder the right to emit 1 million ton of CO2 or CO2 equivalent.
Currencies
Risk adverse investors will continue to seek protection in “safe-haven” currencies such as the US dollar and the Swiss franc.