Private Banking

23 June 2022

Editorial

Recession or stagflation warnings have been bubbling for months amid the war in Ukraine, a world increasingly divided along geopolitical fault lies, coronavirus lockdowns in China, disrupted supply chains and tighter monetary policies. Anxiety that monetary policy makers’ efforts to tame rising input costs may begin to manifest in weaker profit margins has wiped out almost €9 trillion in stock market capitalization this year (-7.8%).

The stock selloff has been driven essentially by falling valuations - the 12-month forward price/earnings ratio is 10% lower than at the beginning of the year -, which have been driven downward by rising bond yields. So far this year, one dog that hasn’t barked is earnings. Expectations for earnings growth have increased by about 7% (in euro) since January 1. But this does not take into account the fact that even a soft landing - a slowing economy that avoids the outright decline of a recession - could still have a bad effect on corporate profits. If sales growth falls below sticky cost growth, earnings and profit margins, which remain historically high, are likely to weaken. Thus there is the possibility that equity investors, like their credit brethren, could face more volatility from here, even if there is a relatively soft landing for the economy.

In this uncertain context, investors should continue to seek hedges by focusing on investment factors like low duration, pricing power, high dividend yield, low volatility and less cyclicality.

  • When it comes to finding a safe haven in stocks, value stocks (especially Energy and Financials), which are characterized by a low duration, should continue to perform better than growth stocks as they are less penalized during rising inflation expectations and higher interest rates. Year-to-date their outperformance amounts to 18% (in euro)!
  • “Defensive” companies, such as Utilities or Healthcare, should keep the lead. Thanks to their lower sensitivity to economic conditions, pricing power, high dividend income or low volatility, they have outperformed more cyclical stocks by almost 16% (in euro) since the beginning of the year!
  • Commodities (+46% since the beginning of the year), along with companies that produce or trade them, will remain the best hedge against inflationary pressures.
  • And finally, investors looking to protect themselves against more market turmoil may start to be less negative about “blue chip” bonds as yields on investment-grade bonds (government and corporate) average now 2.8%, compared with an estimated dividend yield of about 2.2% for stocks.