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Market Insights, June 20, 2022

Each week, our Investment team shares its market views with you !

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Essentials

June looks set to be the worst month so far this year for the US stock markets, which have lost more than 10%. Valuations have dropped sharply and, for the first time since the pandemic began, Price/Earnings ratios for US equities are now trading below their 20-year average. 

China’s economy has been hit so hard by the pandemic that the authorities will have no choice but to introduce stimulus measures. First, tech stocks rallied after the government signalled an easing of its regulatory crackdown on tech companies. Now, the property market is starting to pick back up after several local governments announced steps that will shore up this key sector of the country’s economy.

Emmanuel Macron did not manage to maintain his absolute majority in the second round of the parliamentary elections. This is a setback for the president and has increased political risk in France. For Macron to get his major retirement and unemployment reforms through, the best option will be for him to form an alliance with France’s Republicans. For the time being, the markets don’t seem rattled by this outcome.

Central banks put the brakes on

Central bankers were certainly busy last week. With inflation failing to ease, the major central banks are trying to make up for lost time by picking up the pace of their monetary policy tightening in an attempt to rein in price rises and restore their credibility.

The US Federal Reserve (Fed) has ramped up its tightening, raising rates by 75 basis points, which was more than expected, while the Bank of England lifted its key rate by a more measured 25 basis points.

The Swiss National Bank (SNB) also wants to join in on the global rush to tighten monetary policy. To everyone’s surprise, it used its last meeting before the summer to announce a half-point rise in its benchmark rate, bringing it from –0.75% to –0.25%. This hike came much earlier – and was much greater – than expected. Swiss inflation is well below that of the eurozone, so the SNB’s decision to get ahead of the European Central Bank (ECB) caught most of the market off guard. But once again, the SNB was determined to remain unpredictable and maintain its independence from other major central banks.

In the race to tighten monetary policy, the ECB is by far the most cautious contender – it isn’t expected to raise rates until July. The bond market had largely priced in these policy moves, and long-term interest rates in Europe have soared in recent weeks, particularly in Mediterranean countries. This prompted the ECB’s Governing Council to hold an emergency meeting last week, in order to come up with a mechanism to protect the eurozone’s more cash-strapped countries. The mechanism is expected to be unveiled at the ECB’s July meeting and will no doubt allow for the occasional purchase of sovereign debt from these countries. In addition to the pressure on bond yields worldwide, stock markets have slumped recently.

We recommend holding onto equities at current levels. Stock market indexes are extremely oversold and investors are very bearish. After the rout of the past two weeks, indicators are nonetheless pointing to a potential short-term technical rally.

Alternative funds are holding up well

It has been a rough six months for investors, with stock and bond markets posting steep declines across the board. A quick glance at the press would suggest that alternative strategies have also been hit hard: several large funds have corrected sharply or even gone into liquidation.

But the reality is actually quite different. Alternative fund indexes are only just in negative territory, and some alternative strategies have recorded gains. Long/short equity strategies have posted a very mixed performance. After being buoyed by the market uptrend in recent years, growth-oriented managers with large directional exposure have struggled the most.

But they make up just a small proportion of these funds. Broadly speaking, managers have been cautious and kept leverage and directional exposure low. They even reinforced this approach in recent months and therefore held up well in Q2. Arbitrage funds are down so far this year even though volatility has returned.

Opportunities have been few and far between because managers’ cautious approach has kept indiscriminate sales to a minimum. The situation has improved recently: the June correction was very abrupt and created market dislocations, and managers will be able to take advantage of those trends normalising over the coming months.

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