With declining inflation and the problems of individual banks, investors' focus shifted from inflation to economic growth early in the second quarter. Uncertainty about this dominated with the discussion about the US debt ceiling and disappointing economic data from China and Europe. Investors remained sceptical, favouring large caps, defensive stocks and developed equities. Equity funds saw outflows. Nevertheless, US equities in particular continued to rise. Better-than-expected Q1 corporate results helped, as did AI euphoria, which boosted individual mega caps. However, the main drivers may have been rule-based investment strategies, as more momentum indicators turned positive, implied and realised equity volatilities fell and a negative correlation of equities and government bonds returned with the focus on growth. All of this favoured the build-up of equity positions through rule-based investment strategies.
What's next? The slow decline in core inflation and the robust labour market in the US should allow the Fed to keep interest rates higher for longer. Although the market has already retreated somewhat from the expectation of rapid, significant rate cuts, it is still pricing in more than 130 basis points lower US central bank rates for the end of 2024. However, this is only likely to happen in the event of a more pronounced economic slowdown. The stock markets, on the other hand, seem to be betting on an economic recovery. But if interest rates remain higher for longer and the yield curves remain inverted, this is likely to leave further marks, as already seen in the real estate market, at regional US banks or in the form of tighter credit conditions, falling demand for credit and weaker consumer confidence. Economic risks remain high. In addition, declining net liquidity is likely to become a headwind. The US government's exhaustion of all cash holdings since reaching the debt ceiling in January and support measures by the Fed after the Silicon Valley Bank failure have increased liquidity despite quantitative tightening. Now that the debt dispute has been settled, spending cuts and a significant withdrawal of liquidity are likely to weigh on markets. In addition, the risk of rising US unemployment and, therefore, fewer ETF inflows remains. The higher equity positions of systematic strategies make markets more vulnerable. In the event of a rise in volatility or a more positive correlation between equities and bonds again, e.g. due to the withdrawal of liquidity, these may be forced to reduce equity positions in a falling market. Caution therefore remains the order of the day. The upside potential seems limited for the time being given the multitude of risks and simultaneously increased valuations. However, with a view to a coinciding economic upswing on both sides of the Atlantic in 2024, we see longer-term potential for equities. Still, we expect better entry levels in the second half of the year.
In the Insights interview, our fund manager Javier Garcia explains what excites him about Asian emerging market equities, where he sees opportunities and what distinguishes the Berenberg Emerging Asia Focus Fund. I wish you an exciting read.
Prof. Dr. Bernd Meyer
Prof. Dr. Bernd Meyer has been Chief Investment Strategist at Berenberg Wealth and Asset Management since October 2017, where he is responsible for discretionary multi-asset strategies and wealth management mandates. Prof. Dr. Meyer was initially Head of European Equity Strategy at Deutsche Bank in Frankfurt and London and, from 2010, Head of Global Cross Asset Strategy Research at Commerzbank. In this role Prof. Dr. Meyer has received several awards. In the renowned Extel Survey from 2013 to 2017, he and his team ranked among the top three multi-asset research teams worldwide. Prof. Dr. Meyer is DVFA Investment Analyst, Chartered Financial Analyst (CFA) and guest lecturer for "Empirical Research in Finance" at the University of Trier. He has published numerous articles and two books and received three scientific awards.