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Market Insights – May 16, 2022

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

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2022.05.16-point-des-marches-piguet-galland-banque-investissements

Essentials

China’s economic data for April confirmed the slump already signalled by high-frequency indicators. The lockdowns imposed in response to the spike in COVID-19 infections caused industrial production to fall by 3% year on year and retail sales to drop 11%. The Chinese stock market seems to have partially priced in this slowdown and investors are now focusing on the rebound expected in the months ahead.

After an already-tough start to the year, digital currencies were hit by the fallout from Terra’s crash last week. Bitcoin dipped below USD 30,000 and Ether below USD 2,000 – both key support levels.

Unsurprisingly, the latest economic news from Germany is not good. Industrial output dropped 3.9% in March as a result of the war in Ukraine and the lockdowns in China. However, the ZEW indicator has picked up so far this month, a sign that investors are now less pessimistic about the country’s economic outlook and that companies are adjusting to the new economic climate.

A stellar performance from the US dollar

The US dollar’s appreciation has gained pace recently, with the greenback now rising against a swathe of currencies. US dollar indexes show that it has been exceptionally strong against all of the world’s other major currencies in recent months and is now at its highest level in more than 20 years.

For a long while, the Chinese yuan was one of the only currencies capable of keeping pace with the dollar. But the yuan has fallen back since the Chinese government decided to temporarily put the brakes on economic growth in order to stem the spread of COVID-19.

As a safe-haven currency, the dollar has also been buoyed by the financial market downtrend.
But the main reason for the recent rally is the change in the US Federal Reserve’s monetary policy: recent rate hikes and the ones set to come in the months ahead have spurred the dollar’s rise. That’s because the Fed is the central bank that has taken the most aggressive policy action. And that action is justified, given the sharp rise in consumer prices. Although there are early signs that inflation may have peaked, it still came in at an annual rate of 8.3% in April, remaining at a level not seen since the early 1980s. So the interest rate spread has tipped in the States’ favour, which has brought in large amounts of international capital and pushed up the dollar.

Among the world’s major reserve currencies, there aren’t many other attractive options at present – both the European Central Bank and the Bank of Japan are keeping rates at rock bottom for the time being. But currencies tend to be seen as adjustment variables between economies. And a stronger currency can be used to rein in inflation, although it eventually starts to hamper the country’s competitiveness as well. A major expansion in the US trade deficit will probably mark the end of the dollar’s current run in the months ahead. In the meantime, the dollar should continue to rise.

Upping our exposure to the US market

It was a choppy start to the year for US equities. Inflation was more persistent than initially expected, forcing the Fed to take a much more hawkish stance. This monetary tightening caused a major slump in the world’s highest-priced stock market. Growth stocks, including tech stocks, were hit hard by the rise in interest rates. The poor YTD stock market performance reflects investors’ fears about the prospects for the global economy, and particularly the US economy. But we think a recession can be avoided and expect a soft landing instead.

On a more positive note, inflation – the markets’ main cause for concern – seems to have peaked in March. In April, annual inflation even eased compared with the prior month, coming in at 8.3%, the first such decline in close to 12 months. As inflation normalises, this should cause long-term interest rates to level off and prompt equities to start moving back upwards.

Given that valuations have dropped and sentiment indicators are in extremely bearish territory, we think it’s time to reduce our underexposure to the region. We therefore recommend increasing investments in US equities, with a focus on the quality stocks that have put in the worst performance so far in 2022.

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