“Recession is a distant scenario, but watch out for inflation”


From Julia Schiro
February 23, 2023 08:00

The first two months of this year remind investors of a valuable lesson: it is dangerous to rely on market expectations that are inherently irrational. Investors already envisioned rate cuts and central bank pivots that would propel stocks into an unexpected rally in both equities and bonds, but those expectations are unrealistic. It is true that the macroeconomic scenario has surprised on the upside and a recession is much less likely, but we still support it Caution, especially regardinginflation“.

He said it yesterday at the webinar “Recession YES/NO?” Alessandro Tentori, investment manager of AXA IM Italy (in the photo) and refers in particular to the ongoing review process of the macroeconomic scenario forecasts. The past year ended with bleak prospects on which winds blew recession both in the United States and in the Eurozone. The only country that made a significant contribution to global GDP growth was China.
Expectations have been turned upside down in the last two months. For example, China went from a growth rate of 3% in 2022 to a growth forecast of almost 6% (even higher for some) for the current year after health restrictions were lifted.
Growth also surprised on the upside in the United States and Europe, whose economies, according to analysts, suffered the final blow from the war in Ukraine. In particular, growth in the euro zone was forecast by the consensus of economists to be slightly negative and the recession is considered inevitable, while the large institutions such as the OECD and the IMF, but also individual investment houses, are now assessing the old continent in 2023 at a rate of at least + 0.4% grow.
In the United States, after a sharp slowdown in the second half of last year, forecasts for growth in 2023 have gradually improved on the back of surprisingly strong macro data, both on the labor market side and in terms of consumption and business and family confidence .

Inflation remains the sore point for markets

For its part, however, inflation is struggling to fall at the rate expected by the market, despite massive interventions by the major central banks. Tentori said in this regard:

The excessive optimism that financial markets exuded in January was denied by the stern stance of central banks in February, and the market, realizing that the battle against inflation is not yet won, has rolled back and wiped out the results from the beginning of the year. In our view, this inflation has viscosity components that prevent a radical decline and make it difficult for central banks to cool it down. It is paradoxically easier to bring inflation down from 10% to 6% than to bring it down from 6% to 4% precisely because of these persistent components, such as China’s demographics, supply chain fragility and green transition uncertainties“.

The recession scenario is far away

This ongoing review process prompts AXA IM’s analysts to take this into account two factors to formulate the asset allocation for the coming months:

  • macroeconomic side, the recession scenario is further away or in any case be postponed to the second semester;
  • However, inflation persistsbut it’s a cross and a joy: a problem markets are having to live with, but a reflection of the economy and jobs back in full swing.

Consequently, the mantra “good news for the economy is bad news for the market” remains in the markets, in the sense that an economy that does not slip into recession would allow central banks to focus on managing inflationary risk , without having to deal with the accompanying costs of a restrictive monetary policy, such as an increase in unemployment. AXA Investment Manager Im clarified:

While we are not hostile to growth, we remain fearful on inflation and believe an active but prudent decision-making approach will pay off in markets, particularly in the first half of the year as central banks’ fight against inflation is yet to come is finished yet. The stock market has suffered less than feared following the outbreak of war in Ukraine as underlying fundamentals are solid. As a result, our asset allocation takes into account the improving macroeconomic environment and the risks of above-target inflation for a longer period than currently forecast“.

AXA IM’s proposed asset allocation for the coming months

With this in mind, Tentori summed up theasset allocation suggested by AXA IM for this year:

  • Prudent attitude to interest rate risk, which limits risk and interest rate sensitivity Shortening the term of bond investments and limiting them to bonds with a maximum term of 3/4 years;
  • a stronger risk orientation on the credit market, then on corporate bonds, because the balance sheets of both American and European companies weathered the shocks of 2022 very well. Supporting this view is the fact that the default rate on US high yield is near historic lows at 2.6%. nearly 3 percentage points below historical average;
  • a balanced approach between value and growth in equity markets, which no longer favors massive exposure to tech giants, which are more sensitive to interest rate hikes, as it has in recent years, but focuses on high-dividend stocks;
  • careful regional diversification, because changes in perceptions of monetary policy have disruptive effects on currencies, as happened in Japan.

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