GLOBAL MARKETS
The summer rally looks to us to have very flimsy foundations and the last week has shown some of the inevitable cracks in the recovery narrative. Nothing has been solved and the firm rise in equity prices – led by the US – seems to be based around a belief that the Federal Reserve will pivot soon, and rates will not rise much further. This seems to have been encouraged by a few slightly weaker inflation data points in the US, but it seems naive to think they justify central banks not taking action to contain rising prices and what looks like a serious cost of living crisis both in the US and across the globe. Of course, investors are probably right to think inflation will ease to a degree, but it might be for rather worrying reasons – as always with markets, be careful what you wish for. Attention is soon likely to focus on the deterioration in the global economy and the possibility of recessions in many countries. This will probably bring a pause in monetary policy tightening if/when the recessions are confirmed, but can the Federal Reserve do much if inflation has not come down without upsetting the bond market and losing credibility? Remember too, that we are only just getting started in terms of tightening and the withdrawal of liquidity, aside from headline rate rises. If we get lucky, inflation will ease, and the economy will stay relatively strong (though consumer and employer sentiment is decidedly weakening) but lucky is the right term here. We are equally as likely to face a weak economy while inflation is stubbornly high – the dreaded “stagflationary” scenario. Of course, there are many possibilities in the middle of those extremes, but it takes a real optimist to expect a smooth landing here. True, Q2 company results have been better than expected but they are a lagging indicator of economic conditions and not a reflection of the challenges ahead. The second quarter of the year is likely to prove very challenging and earnings and margins (historically at very high levels and correlated negatively with labour costs which are rising) are likely to face stiff headwinds. This really does feel like a time to focus on capital preservation rather than chasing any recovery in asset prices – bear markets typically feature multiple, very strong rallies and we think the real opportunities are yet to present themselves.
EUROPE
Europe looks to be in a pretty wretched place, economically. The energy crisis there is particularly grave given the dependence on Russian supplies and even the once-mighty German economy looks to be in real difficulty. Recession across the continent sems inevitable and policy makers are even more constrained in their ability to control inflation through rate rises. Debt to GDP ratios in the most troubled countries such as Greece and Italy have continued to rise and the vulnerabilities to increased costs of funding are a major problem. Economic, political and social challenges are all likely to worsen against this backdrop and only an incurable optimist would make the case that the winter months are going to be anything other than severely challenging. The euro is likely to show continued weakness which may be of some short-term benefit to large multinationals and their share prices, but this will be overwhelmed by the currency’s worsening of the cost-of-living crisis and the recessionary impact. We are holding positions this month but actively discussing Europe’s role in portfolios.
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