Keep it balanced

Investment Policy, October 2021

Keep it balanced

The key capital markets look to be entering a new test phase as the days start to shorten. Although a normalisation of US monetary policy appears imminent, it is likely to be effected slowly. At the same time, key indicators of economic development such as the employment situation and consumer spending are coming under scrutiny against a backdrop of possible coronavirus developments and production bottlenecks. Has global economic momentum now passed its peak, or are we just seeing a shift of dynamism between regions? Due to the absence of clarity and uncertainties surrounding China, a balanced spread of investments covering the key asset classes looks to be the sensible approach.

The onset of autumn could prove a test for the financial markets. With inflation now higher than it has been for many years, market participants could start to question the extreme expansionary monetary policy still being pursued by the US central bank (Fed). A number of emerging market countries have already responded to higher inflation levels by increasing interest rates. Although it is conceivable that less robust economic data could have a calming effect on inflation rates, rising employment is an important driver of wage development, and has traditionally played a key role in the Fed’s thinking. Moreover, coronavirus developments – specifically the very infectious Delta variant – call for continuous monitoring. Imprudent behaviour both during and after the autumn holidays could have an impact on global consumer spending, which has so far recovered impressively. What matters here is not just the reaction of governments to the proliferation of the Delta variant, but also the extent to which cautious consumer behaviour – whether it be shopping, going out for the evening, or going on holiday – could weigh on economic momentum. Finally yet importantly, developments in China (as highlighted in our last Market Comment) remain an unpredictable but important factor for the direction of the economy and financial markets.

Equities

Equity markets appear to have anticipated the recovery of economic activity and corporate earnings by increasingly factoring these aspects into market prices. However, growing uncertainties now look set to increase volatility. A key question here is whether the economic recovery has now passed its peak, and the extent to which global economic growth could wane as a result. Modern valuation models suggest that equity valuations are historically above average, but they still look attractive compared to bonds. Greater uncertainty over inflation and interest rate policy will increase the probability of higher volatility generally over the next few months. What’s more, ongoing supply shortages of key intermediate goods and component parts can be expected to make economic data more volatile too. In such an environment, it makes sense to combine “medium-term economic optimism” with “seasonal prudence”. We are therefore focusing on Eurozone and above all Swiss equities, which traditionally exhibit lower betas (i.e. lower sensitivity to global equity market movements).

Resurgent uncertainties call for a more balanced spread of asset classes.

Gérard Piasko, Chief Investment Officer


Bonds

A decline in inflationary expectations or an equity market correction could further depress yields in the key bond segments. Until the inflation uncertainty has died down, investors should remain focused on corporate bonds: these continue to enjoy support in relative terms due to their yield advantage over government bonds. Default rates continue to decline in both the “investment grade” and the “high-yield” segments, with the latter’s additional yield explained by lower credit quality. But another aspect to watch is the relationship of yield to duration. Over the coming months, the shape of yield curves in both the US and Europe could undergo a number of changes. Here there is likely to be a shift between flatter and steeper yield curves, in keeping with the difference in yield between long and short maturities. As such, it could make sense to adopt a neutral positioning where the duration of the bond portfolio is concerned.

Currencies

The currency markets are primarily being influenced by the various changes in direction of the US dollar now. In this context, it will be particularly interesting to see how the relationship between US fiscal and monetary policy develops going forward. Any shift towards a gradual normalisation of monetary policy via the tapering of government bond purchases, followed later by an increase in short-term interest rates, would support the US dollar as long as European monetary policy remains expansionary. By contrast, any market disappointment over (i.e. any reduction of) fiscal stimulus could hurt the greenback, as the economic growth advantage enjoyed by the US over Europe would recede. Until the development of these two crucial factors becomes clear, it is conceivable that EUR/USD will continue to oscillate in a more volatile bandwidth of 1.15-1.20. This could also have the effect of making CHF/EUR more susceptible to volatility.

Commodities

With the demand side having been the main driver of global commodity market movements for many months this year, the supply side is now becoming more significant, particularly in what is probably the most important global commodity of all – crude oil. Although the crude oil inventories have been continuously reduced, this process could continue without affecting their ability to service a significant proportion of demand. More important to future supply will be the reaction of US shale oil producers and the level of production discipline shown by OPEC and Russia. A price war (i.e. a battle for market share) of the kind seen in early 2020 should be avoided, but so too should a wholly uncoordinated “every man for himself” attitude. Ultimately, economic demand will remain the main driver, but any uncertainties over supply could repeatedly lead to further spikes in volatility. In such a scenario, the relative stability exhibited by oil over the year to date compared to other commodities would then be likely to wane.

Gérard Piasko

Gérard Piasko

Gérard Piasko is Chief Investment Officer and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years Chief Investment Officer of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Important legal information:

This publication is intended for information and marketing purposes only, and is not geared to the conclusion of a contract. It only contains the market and investment commentaries of Maerki Baumann & Co. AG and an assessment of selected financial instruments. Consequently, this publication does not constitute investment advice or a specific individual investment recommendation, and is not an offer for the purchase or sale of investment instruments. Maerki Baumann & Co. AG does not provide legal or tax advice. In addition, Maerki Baumann & Co. AG accepts no liability whatsoever for the content of this document; in particular, it does not accept any liability for losses of any kind, whether direct, indirect or incidental, which may be incurred as a result of using the information contained in this document and/or arising from the risks inherent in the financial markets.

Editorial deadline: 22 September 2021

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