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Market Insights – May 10, 2022

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

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2022.05.09-point-des-marches-piguet-galland-banque-investissements

L'essentiel

Investor sentiment has become extremely bearish in the States, which could mean that the market is close to capitulating. If inflation starts showing signs of normalising, interest rates might ease and US stock markets could come back in favour.

Year-on-year growth in Chinese exports dropped sharply in April, but at 3.9%, it was still slightly above the consensus forecast. As expected, demand has slowed after two bumper years. On top of that, the pandemic-related lockdowns remain in place, which is squeezing supply chains.

Europe’s Q1 earnings season went largely unnoticed. But the results were good: 63% of companies did better than expected, while just 25% missed their estimates. The best surprises came from value stocks and very large caps, such as financials, materials and energy stocks

The worst year for bonds in a long while

We all know it’s been a tricky start to the year for the stock markets, but we often overlook just how tough it has been for the bond markets too. For many years, bonds defied expectations and chalked up a string of positive performances as yields continued to plunge to unprecedented lows.

Long-term interest rates entered negative territory in large parts of Europe, including Switzerland, and further afield as well. In late 2020, the world’s pile of negative-yielding debt hit an astounding CHF 18 trillion.

But the era of negative rates is coming to an end, and it’s been a rude awakening for bond investors. With the exception of Japan, most bond markets in  developed countries have declined by close to 10% so far this year. This includes the Swiss market, which has rarely seen so much negative volatility. The declines have been greater than during the great bond market massacre of 1994, as investors have become all too aware of the threat of inflation.

On top of that, central banks have begun tightening their monetary policies. Last week, the US Federal Reserve picked up the pace of its tightening by raising its benchmark interest rate by 0.5%. Within Europe, the Bank of England has also begun hiking rates; the European Central Bank should follow suit in the second half of the year, and the Swiss National Bank may do the same in 2023.

Long-term interest rates (i.e. ten years or more) usually stop rising well before the short-term interest rates controlled by central banks do. This is known as a flattening yield curve, something we’re likely to see in the months ahead, starting in the States. At around 3.25%, US 10-year interest rates now offset long-term inflation expectations, which have levelled off over the past two months – a sign that investors think inflation will soon peak. We have started to buy longer-dated US bonds, and it may soon be worth doing the same for Swiss and eurozone paper.

Alternative funds – effective protection

There are many causes for concern at the moment. Over the past six months, financial market volatility has been fuelled by the invasion of Ukraine, soaring oil prices, style rotations and rising bond yields.

However, hedge funds have held up well in this challenging climate and withstood bouts of market weakness. They’ve posted a relatively flat YTD performance, while bond and equities markets have lost more than 10%. This resilience can be attributed in part to the cautious positioning that managers have gradually adopted since the summer of 2021.

We believe that alternative strategies will maintain their current configuration – with low exposure despite the market downtrend – and continue to offer reliable protection during times of stress.

We are still taking a barbell approach in our portfolios, with a focus on long/short equity funds. In addition to participating in market upside, managers are able to take advantage of the broad reduction in equity research budgets among brokers and the decline in short positions to a 20-year low, all of which generates exploitable inefficiencies.

At the same time, we are bullish on arbitrage funds, with a preference for managers who focus on volatility (e.g. through convertible bonds). That’s because we believe volatility will remain high. These strategies also tend to perform well when the markets are under pressure, making them an attractive source of diversification.

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