Global inflation is still high and a recession is probably near. Therefore, asset manager AllianzGI foresees a bumpy second half of the year. But with the right timing, potential entry points could emerge for investors in equities, high-yield bonds and commodities. However, they should then look for companies with pricing power and anchored around reasonable valuations and structural trends.
“There are several challenges ahead and investors are in for a bumpy ride in the coming months,” believes Stefan Hofrichter, head of Global Economics & Strategy at Allianz Global Investors. “For instance, inflation remains stubbornly high. Annual core inflation (excluding highly volatile energy and food prices) has been hovering around 4% to 5% for several quarters. This is significantly above central bank targets of 2%. Due to second-round effects, such as wage increases, it takes longer for inflation to soften.”
Hofmeister: “Given persistent underlying inflation, we do not share the market’s optimism that the world’s leading central bank, the US Federal Reserve, can afford to cut interest rates in the second half of this year. We expect further interest rate hikes in the US. At the June FOMC meeting, the Fed even pointed to two more rate hikes before the end of the year. And the European Central Bank will probably have to raise more than currently estimated by markets. Therefore, we consider the likelihood of a further fall in bond yields limited.”
Recession is base case
A recession in the US and Europe later this year is AllianzGI’s base case scenario. There are several leading indicators for this: the reversal of yield curves, the contraction of money supply and reaching the peak of the financial cycle (a measure of the joint dynamics of house prices and leverage in the private sector). “The consensus seems to be that the downturn will be mild and shallow. We are not so convinced. The crumbling of the property market, both residential and commercial – as a period of rising prices comes to an end – may lead to a stronger economic slowdown than investors have so far expected,” says Hofmeister.
In addition, Hofmeister points out that the risks of financial instability remain. “Markets for illiquid assets, especially real estate, may prove to be a source of financial instability, as the International Monetary Fund has repeatedly warned. Financial stability considerations will complicate the work of central banks. So far, however, they have shown no appetite to let these financial stability risks get in the way of fighting inflation.”
Although AllianzGI does not expect smooth sailing in financial markets for the rest of the year, investors can find good entry points in all asset classes. Given the growth outlook and following the rise in bond yields in 2022, AllianzGI expects positive returns for bonds – although with no guarantee. “It is a time to remain nimble,” says AllianzGI.
Even more macro uncertainty
According to Virginie Maisonneuve, Global CIO Equities at AllianzGI, investors will be faced with three key questions over the next six months: how quickly will the tightening monetary policy of the past 12-15 months affect economies? What kind of recession or slowdown should we expect? And how will corporate profits hold up under these circumstances? She thinks investors are likely to face further macro uncertainty in the second half of the year due to impending interest rate hikes and a possible economic downturn.
“Our focus for the rest of 2023 is on resilience and long-term structural growth opportunities. Investors should ensure portfolios are resilient to further volatility while positioning themselves for the opportunities ahead, including companies that can withstand higher input costs and pressure on margins,” Virginie believes.
More positive on government bonds
“As expectations around the pace of monetary policy tightening abate and policy rates approach their cycle peaks, we expect volatility in the interest rate market to eventually subside. As a result, we are becoming more positive on government bonds and interest rate eduration, especially in the US where the tightening cycle is more advanced,” states Franck Dixmier, Global CIO Fixed Income at AllianzGI.
Dixmier is also positive on the US regional banking sector. “The likelihood of widespread regional bank failures is currently low. We remain overweight in systemically important European and US banks with sufficient capital and diversified funding and earnings,” said Dixmier.
