Analysis on the current situation in the financial markets by Guy Wagner, Chief Investment Officer at BLI - Banque de Luxembourg Investments
Short-term factors
Central banks have made the fight against inflation their primary objective. However, monetary tightening policies are not able to improve the situation on the supply side. Thereore, the only way to reduce inflation is to reduce demand.
The rise in interest rates will thus have an impact on the economy, which is likely to slow down, while inflation will gradually decline. Inflationary fears will progressively give way to fears of recession.
A reversal in the Federal Reserve's monetary policy, similar to what happened in 2018, is not yet on the agenda. Such a reversal, at a time when inflation remains high, would completely destroy the credibility of the US central bank. For the US central bank to change its stance, one or more of the following factors would have to occur:
A much more visible slowdown in US economic growth;
A decline in inflation for several months in a row;
A further fall in stock prices;
The occurrence of one or more major accidents in the markets (bankruptcy, etc.)
In the short term, the markets will therefore remain under pressure. The more since:
The current market decline must be put into perspective. At the current level (3,924), the S&P 500 index remains some 4.5% above its level from the beginning of 2021 and 16% above its level before the health crisis. In essence, the market has 'only' lost the gains of the last twelve months (although it should be noted that behind the 'good' resilience of the indices there is often significant damage);
Valuation multiples and company profit margins remain high.
Medium-term factors
The rise in US bond yields is starting to lose steam.
Monetary tightening in the US will ultimately be less aggressive than what the Federal Reserve is currently suggesting and what the market is anticipating.
Quality companies will regain favour with investors. Their valuation multiples have become more reasonable and they are better positioned to protect their profit margins.
The dollar's rise is coming to an end.
Valuation multiples in Asian markets are generally attractive. The strong undervaluation of the yen is an additional argument in favour of the Japanese market.
The outlook for gold remains favorable in the medium to long term.
