The Big Picture THE BIG PICTURE: INVESTORS FACE RISKS ON MANY FRONTS Key


near-term risk


↘ bonds ↘ Stocks correlation +


As 2022, positive stock/bond correlation driven by inflation & monetary policy tightening


Typical in recovery/boom. Hard to achieve just now given rich equity valuations versus bonds


↘ bonds ↗ Stocks correlation −


Supply shock, e.g. higher


commodity prices Stagflation


Rate hikes / less cuts


Solid economy Greedflation


Strong risk appetite


Monetary policy unchanged or slightly tighter


Growth


disappoints Risk aversion Disinflation


Slow / delayed rate cuts


Goldilocks


Recovery, disinflation


Productivity shock (+) Rate cuts


↗ bonds ↘ Stocks correlation −


Near-term bias


Typical in early downturn Possible near term, and made easier by cheap bond valuations versus equities


Positive stock/bond correlation often requires monetary policy dominance easing


↗ bonds ↗ Stocks correlation +


Medium-term bias


The short-term picture is full of risks, finds Andrew Holt, which can mean opportunities and challenges for investors.


Looking to the end of 2023 and into 2024, many risks exist which are likely to have ramifications for investors. For example, the surge in oil prices adds new stagflation risks. Brent prices have climbed to around 25$/bbl in the three months to late September – just 3$ below the 100$ mark. This is most unwelcome for investors, as this will keep headline inflation higher in the final quarter of this year and hurt growth.


The price pressure reflects a shortage of supply, after OPEC+ cut production targets, under the leadership of Saudi Arabia and Russia. Although, this must be seen in the context of a moving geopolitical environment, with Saudi Arabia joining the BRICS group.


On the political front, 2024 will see EU and US elections where inflation and immigration are major concerns for the incumbents. Joe Biden and Ursula von der Leyen have run highly active energy transition policies, and it is not in the interest of the fos- sil energy industry to support their campaigns. Investors may thus face the risk of higher energy prices for longer into those crucial elections.


Using an interesting investment clock device (pictured) to assess the outlook, Generali Insurance Asset Management looks at stock and bond performance from the correlation angle.


Correlation is positive in the top left – bottom right diagonal, and negative in the other. Generali’s view is that markets will turn the year in the top-right corner, with the global slowdown capping bond yields and hurt- ing a generous earnings consensus and equity valuations. Consensus has US corporate earnings up 12% for 2024 and 2025, and up 7% for Europe. This looks optimistic and subject to downward revisions, Generali said. The key risk is that global markets turn the year in the top-left corner, as rising energy prices, and possibly food prices, as El Nino disrupts the agricultural complex, keeping inflation high and central banks hawkish. Longer term, Generali expects a transition to the bottom right corner – more bullish within six to 12 months, as the Fed starts to consider rate cuts by mid-2024. Sustained commodity price inflation may well delay that transition. A near-term defensive bias also lies in the valuation gap between ‘risk-free’ bonds and equities. Furthermore, rate vola- tility has been high relative to equity credit and FX volumes, and this has played against bonds. Equity markets delivered solid year-to-date gains into the early summer in the context of a continued central bank quantitative tightening. But with the latter comes the risk of some payback to a quantitative easing-furled risk rally. Therefore, it is safe to say, the future is full of risk for investors, which, if navigated well, can offer opportunities as well as challenges.


Issue 127 | October 2023 | portfolio institutional | 9


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