In the last two months there has been a change of course compared to last autumn's forecasts and now "the probabilities of the occurrence of a deep recession have objectively decreased,” he says Luca Simoncelli, Invesco strategy. The main risk in this market phase lies in a “countertrend movement in the inflation rate” after a period of decline. The “corporate bonds, investment grade but also high yield, are a very important tool” in the construction of a balanced portfolio and offer an alternative with an attractive risk/reward profile. Short maturities are better for government bonds, European and Asian markets are better for equities.
Last autumn, very gloomy forecasts were made for 2023 which included a further rise in inflation, with gas prices still skyrocketing, declining company profits, recession, a very weak business market. Instead, we started the year with a completely different panorama: toned stock market, corporate bonds and fixed income as well, falling inflation and decent economic growth. How should one navigate with the new data?
“The macroeconomic data of the last two months have highlighted a resilience of the economy in the United States as in Europe. Indeed, in Europe, a solid trend of economic data has developed which has positively surprised market expectations. We believe the odds of a deep recession occurring have objectively decreased."
Do you evaluate the new solid trend or just a technical rebound on the lows? Is it the rally that is often seen in January?
“Recent developments on the macroeconomic framework have generated an upward revision in growth expectations and underlined the stability of economic fundamentals at a global level. Let's think about consumer spending in the light of a fall in energy prices in Europe, the reopening of production chains in Asia and the solidity of the labor market in the United States. In terms of profits of listed companies, the slowdown is clearly underway and the contraction in operating margins is clearly evident. However, this movement is accompanied by a rise in the risk appetite of investors who have already had time to anticipate a very difficult scenario for economic activity”.
What are your forecasts on the various economic fronts?
“We don't have an investment process based on precise forecasts of growth and inflation. However, our focus is on determining which macroeconomic regime we can expect to predominate over the next three to six months and especially on identifying inflection and trend reversal points. We believe that one of these transitions already took place a couple of months ago, establishing on the market a regime of 'recovery' both in the economy but above all in the investors' appetite for risk. The rally in equity and corporate bond markets is justified in our view. The main risk in this phase of the market lies in a countertrend movement in the inflation rate, above all in Europe, where, that is, after three months of declines, inflation does not continue to fall and rather rises again”.
How is it better for the investor to orient himself? Is the stock exchange or fixed income better? The short or the long term?
“We believe that corporate bonds are a very important tool in building a balanced portfolio, therefore we recommend an overweight in the investment grade segment, but also in high yield. On the government component, which in any case returns to offer a hedge against the risk of recession, we maintain a low duration and a preference for the US market, while an underweight on Europe. Obviously equities fit well with our reading of the current market environment. However, we suggest an active approach both in terms of regional and sectoral asset allocation, and with a preference for funds actively managed by stock picking specialists. At the moment our preference is on markets in Europe and Asia, while at a sector level we balance a more defensive exposure to consumer staples and pharmaceuticals with higher beta positions such as US tech and European mining”.
With regard to fixed income in particular, should we expect a reduction in yields if monetary tightening were to ease? How are the curves, which have remained inverted for a long time, behaving?
“Yes, the easing of monetary tightening would lead to lower market rates, however this is not our baseline scenario. The first movement to reduce inflation from very high levels down to about 3,5% - 4% now appears to us to be in progress and fully achievable, however the second step of the reduction, i.e. from 3,5% - 4% to the 2% target will require more patience. The rate curves in fact, they have the possibility of remaining inverted for a few quarters, at the moment the central banks are announcing the establishment of a period of pause in monetary policy once a sufficiently restrictive reference rate level has been reached. The bond market does not fully believe the FED's message and in the projections implicit in the "forward" market, a cut would already be partially discounted".
The recent Eni bond saw huge demand. How do you explain it? What are investors looking for?
“In general, I can confirm that current financial conditions are favorable for the inclusion in the portfolio of asset classes capable of generating yield and coupon flow, this I believe is well represented by investor interest. The market phase in which a purely “growth” approach is the only winning strategy is now behind us, corporate bonds now offer an alternative with a much more attractive risk/return profile”.
In the US it is being said that the 60-40 portfolio split seems outdated. What do you think? Is it the same in Europe?
No, the 60/40 Balanced Portfolio is not outdated. Medium-term periods in which correlations between asset classes do not help portfolio diversification are by no means a rarity both in the USA and in Europe. With the transition, certainly not painless, to a regime of positive real interest rates and a monetary policy that must once again manage the slowdown of the economy and not just the accelerator, a more 'total return' type approach is fundamental. Today it is once again possible to construct balanced portfolios in terms of capital account growth and coupon flow. We have appreciated in the recent past the diversification potential that alternative investments can bring, we believe that a higher allocation is warranted. However, the liquidity characteristics of the investment should be viewed with caution.
What economic/monetary events do you expect from foreign countries that could change the situation in Italy, net of the ongoing conflict?
“The risk of excessive monetary tightening and the possible management of a possible rise in inflation certainly place the European Central Bank in the spotlight. The economic recovery in China has the potential to contribute to higher profits for companies especially in Germany and Italy.
