Paintrade risk is looming

The markets got off to a brilliant start in the first weeks of the new year. Not only equities with +6.3% and bonds with +4% have started positively, but also alternative investments such as gold are trading with a whopping plus of 6.6%. As an investor, one could get the feeling that the central banks are already propagating quantitative easing (QE) again. This is definitely not the case with further expected interest rate hikes from the European Central Bank (ECB) and the Federal Reserve (Fed) at the beginning of February. 

The capital markets currently expect the Fed to succeed in a picture-perfect soft landing of the economy and inflationary pressures to soon vanish into thin air. In our view, markets have increased the challenge for central banks, led by the Fed, in recent weeks as financing conditions have started to loosen again. The reasons are obvious – rising equity prices, a weaker US dollar, falling interest rates and lower bond credit spreads. It remains to be seen how the Fed will react to these movements in terms of communication at its next meeting.

Less bad is not good

Earnings season is in full swing and negative earnings revisions are likely to continue in the first half of the year. Equity markets are signaling that while the earnings situation is not rosy at the moment, with the soft landing narrative described above as well as sharply falling inflation rates, higher price-earnings ratios (P/E ratios) can be paid again. At the moment, earnings for the S&P 500 are estimated in the range of 210 to 220 US dollars. At 4100 points, this implies a P/E ratio of 19, which is historically high (table 1).

The margin for any mistakes is very small in our view. In addition, the earnings yield of the S&P 500 is around 5.5%, which is no higher than the yield of a short-term corporate bond, which has a clearly lower risk profile. The equity markets outside the US have a more attractive valuation, which is why global equities ex USA are to be preferred to US securities.

High liquidity

Despite the rise of many asset classes, money market funds have received a strong inflow in recent months. As graph 1 impressively shows, around 5 trillion US dollars are parked in liquidity.

Thus, there is a risk for investors in the coming weeks that the classic pain trade could continue to drive prices higher. In today's investor world with benchmarks and peer groups, the pressure is constantly increasing and the fear of underperforming in the short-term is growing.

Investment strategy - selective opportunities

The brilliant start to the new year described above has boosted almost all asset classes, and the January effect and seasonality are particularly strong this year. We are sticking to our cross-asset strategy – bonds are preferred to equities. We see very selective opportunities in almost all asset classes, especially in investment grade bonds, which continue to have an attractive risk-adjusted return. This is also the reason why we continue to increase the share in the portfolios at the expense of liquidity. This increases the risk profile only very slightly.

Equity strategy

Our equity positioning remains defensive as valuations are in the top quartile. We prefer the pharma and financial sector. In consumer discretionary and technology companies, we maintain our “unattractive” rating. Within financials, we would once again like to focus on banks. Especially European banks, which today have a higher profitability and are valued lower. But we also rate insurance stocks as attractive due to the attractive dividend yield in combination with share buyback programs.

Fixed income strategy

The bond segment in a multi-asset portfolio remains attractive and we continue to maintain a neutral duration. We continue to build up investment grade bonds and also have a preference for government bonds. We remain cautious on high yield bonds, as in an economic downturn there is usually an increase in credit defaults. The spreads are unattractive for the expected risks, in our view.

Alternative investments

The challenges for the investor year 2023 remains despite a brilliant start. Therefore, our focus remains on low correlated components such as hedge funds and liquid alternatives, which are rated as attractive. We continue to find gold attractive in the long-term, but after the strong rally we would only add to the position in the event of setbacks.