The past half-year has proved one of the most troublesome in the last 40 years. Both global equities and bonds have fallen, and day-to-day and week-to-week volatility has been on a par with or higher than during some of the previous crises we have experienced.

High inflation was the all-dominating theme for the financial markets. Pedal to the metal on monetary policy normalisation triggered a surge in interest rates, while uncertainty on the future trajectory of inflation and tough talk from the central banks stoked rampant financial market volatility that caused risk premiums to increase significantly.

Read the whole Q3 Asset Management Quarterly View report here

The time ahead – macroeconomy
US: Are we on the threshold of a US recession?
US economic data have been something of a paradox in H1 22. On the one hand, the national accounts showed negative growth in Q1, while estimates for Q2 indicate growth was not particularly high, though nonetheless positive. On the other hand, the labour market has proved extremely robust and job creation very high. At this moment, we do not expect a recession. Rather, we expect growth of 1-1.5% over the coming 2-4 quarters – in other words, growth below the economy’s long-term potential.

We estimate that current inflation is far above the underlying trend, which we assess to be a little above 2%. If we are correct in our assessment, the Federal Reserve will not have to send the economy into recession to get inflation under control. On the contrary, inflation should begin to decline in the coming 6-9 months. This, together with clear signals from the Federal Reserve, should put a lid on inflation expectations. We would emphasise, however, that the level of uncertainty is high.

EUROPE: More dependent on the course of the war
Growth has slowed in the eurozone as well. Manufacturing has long been weak – squeezed by high materials prices and supply chain challenges. Up to now, however, the service sector has had a tailwind from the reopening, which is why the broader economy has been growing strongly, as symbolised by still high employment growth. But that is history now.

While we again do not expect an actual recession here, we would emphasise that the eurozone is more vulnerable to unforeseen shocks. The war in Ukraine and the broader conflict with Russia is clearly the key risk here. Should Russia shut down gas supplies, or the region decide to end energy imports from Russia faster than we are counting on, growth will slide into negative territory.

CHINA: Has Omicron under control as normalisation continues
China appears to have bounced back after Omicron. However, China still faces a tough battle with Covid-19, as the Middle Kingdom is not yet ready to abandon its zero-covid policy. We therefore continue to expect sporadic and targeted restrictions that from time to time will create headlines and have a negative impact on the economy.

Nevertheless, China has proved that a modest reopening is possible with frequent testing and rapid lockdowns as the key intervention measures. At the same time, the government is still enacting initiatives that can support the economy. While we do not expect major easing on a par with previous stimulation, this is still a moderately positive factor. We therefore expect growth over the summer to be a little above the economy’s long-term potential.

The time ahead – the financial markets
EQUITIES: Could rise at a decent pace
At the end of last year, we assessed the risk premium on US equities to be too low, meaning the US equity market was overvalued to the tune of about 15%. However, as this year kicked off, we expected that solid growth and declining inflation would keep the risk premium at this low level. We were wrong.

We now estimate the risk premium on US equities to be a little above the long-term fair level, which means we view US equities as being priced slightly cheap – by around 5%. If our expectations pan out, i.e. the US economy avoids a recession and the bulk of the growth slowdown is now behind us, a degree of calm should descend on markets and the risk premium should even fall a little. We therefore expect that US equities could rise at a decent pace in the coming 12 months. This unfolding as we anticipate would also boost global equities to a similar extent.

BONDS: Expect more stable fixed income markets
The Federal Reserve and the ECB are set to send short benchmark rates considerably higher in the coming 3-12 months. Only an abrupt fall in inflation or a relatively pronounced recession can halt this in the near term. This will put a floor under yields and prevent them from declining much.

On the other hand, we now assess risk premiums across the US Treasury curve to be attractive. Relatively low growth and declining inflation should curb the upward pressure on yields. Our view, therefore, is that US Treasury yields are close to a temporary peak, and we estimate the US 10Y Treasury yield will hover around current levels of 3-3.25% in 12 months, with the risk being tilted slightly to the downside. Turning to Europe, for the first time in more than six months we assess medium to long end yields in Germany as reasonably priced. In contrast to the US, however, levels are not overly attractive.

Overall, we expect considerably more stable fixed income markets in the coming 6-12 months compared to the dramatic half-year we are now leaving behind.

EMERGING MARKETS: Risk premium higher than normal
We continue to assess the risk premium, especially on Chinese equities, as higher than normal, and view the Chinese equity market as the cheapest of the major broader indexes – undervalued by 10% to 15%. Should our expectations for solid growth in China over the summer and calmer global financial markets materialise, equities in emerging markets, spearheaded by China, should deliver decent positive returns in H2 22 – perhaps even above the returns we expect in the US and Europe.

This publication has been prepared as marketing communication and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.