Opportunities for quality bonds - and in China?

Looking ahead to July, we tend to remain more cautious. After the good performance on many stock exchanges in the first six months of 2023, the next months could now become more challenging. The monetary situation remains rather difficult. The US economy is still holding up relatively well, but the economic risks in Europe are increasing sharply: a "soft landing" of the European economy seems unrealistic.

The authors

DJE's strategy team continuously monitors and evaluates the markets using its proprietary FMM methodology based on fundamental, monetary and market technical criteria.  

From the strategy team of DJE Kapital AG 

In euro terms, the global equity index performed well in June, up about +3.52%, boosted by a very good performance of the cyclical consumer and industrial sectors. The broad European market (Stoxx 600) also performed positively (+2.25%), but not as well as the US markets. And while we continue to see economic risks in the second half of the year, opportunities for investors lie in improved relations between China and the US as well as in the bond sector.

Chances

    • Attractive interest with very moderate risk in selected quality bonds
    • Relations between the USA and China may be improving. This could have a positive impact

In the bond segment, we see attractive yields with very moderate risk in quality bonds with maturities between two and four years. Geopolitically, it is becoming apparent that the Chinese government needs to stimulate the economy even more and that China will continue to be strongly dependent on the development of the global economy. Improved relations between China and the USA could have a positive impact on the economies of both countries. In the medium term, we also see opportunities for European companies and (US) companies that are highly diversified in international sales markets and that can benefit strongly from the US Inflation Reduction Act, for example.

Risks

    • Central bank policies risk a recession scenario that is much deeper than desired
    • Deep inversion of yield curves a signal for a hard landing

The central banks' policies are aimed at weakening the economy and generating a (mild) recession in order to curb inflation, which is still too high. However, due to the ongoing monetary braking into an already incipient downturn, there is a risk of eventually ending up in a recession scenario that is much deeper than actually desired. The continuing deeply inverted yield curves - with higher interest rates on short-dated bonds than on long-dated ones - are a signal of a hard landing; in Germany, for example, the last time there was such a strongly inverted yield curve was in the 1990s. A deep and prolonged recession in Germany and Europe means that investors should be cautious about stocks or equities that are heavily exposed to German and/or European domestic consumption.

Fundamental Indicators

    • US economy still relatively good; however, risks to consumption in the second half of the year are increasing
    • Liquidity deterioration and inverse interest rate curve, however, indicate that there could also be a recession in the USA
    • Europe and especially Germany could face a prolonged period of weak growth

Although the US economy is still relatively strong, risks to consumption continue to increase in the second half of the year. The deterioration in liquidity and a continued inverted yield curve indicate that a recession could also occur in the USA. Looking at Germany and Europe, the economic risks are also increasing: we see a significant weakening of the leading indicators and the deep inversion of the yield curve as signals for a hard landing.

Europe and especially Germany could face a prolonged period of weak growth. Current policy measures in Germany should be viewed very critically in our view, as the lack of understanding of industry in politics is likely to motivate some companies to shift their production towards the US or Asia. The productivity trend in Germany has broken, but in the USA it continues to rise.

The Chinese government has realised that more needs to be done to get the economy going and that it cannot do it without America. Improvements in US-China economic relations and some China revival remain possible. Looking at the banking sector, the withdrawal in US bank deposits (and a swap into money market funds) continues. This means that banks that have financed their capital markets business from deposits or banks with high exposure to commercial real estate loans should be viewed critically.

Monetary Indicators

  • Rapid interest rate cuts in the USA appear unrealistic
  • Especially in the euro area, risk that the ECB will apply the brakes too much

As things stand, another one or two interest rate hikes are currently the base scenario in the USA, followed by a plateauing of the Fed Funds rate. Due to the still high core inflation, quick interest rate cuts do not seem very realistic. This would mean that we have to expect an interest rate plateau for some time. In the EU, two further interest rate steps by the ECB are likely. After that, however, there is unlikely to be a rapid decline in interest rates in Europe for the time being. In the euro area in particular, there is a risk that the ECB will apply the brakes too heavily and thus trigger a longer and deeper recession. Perceived inflation will persist for a longer period of time, which also means that wage-price spirals cannot be caught so easily.

Market Technology Indicatores

  • Overall mixed picture

Low put/call ratios and high optimism, e.g. in the Fear & Greed Index, should be seen as countercyclical negatives. On the other hand, high short positions on the S&P 500 and high cash ratios in the Bank of America fund manager survey are positive - the picture therefore remains mixed.

 

 

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