Reasons to be afraid
We believe there is greater potential for earnings disappointment in Europe than in the rest of the world, which is not yet reflected in equity valuations. Another factor clouding the outlook is that bank rates are expected to rise quite sharply in Europe. The policy of the European Central Bank has shifted towards fighting inflation, despite the already pronounced downside risks to economic growth.
A third reason for this larger underweight is the impact of the conflict in Ukraine, which we consider to be particularly intense for European companies close to the cycle and geographically close.
Finally, analyst forecasts predict barely positive growth in the second quarter of 2022. This leaves Europe arguably closer to recession, certainly relative to the US. The impact on corporate earnings would be greater given the high operating leverage of European companies.
Risks to future consumption – and growth
In the United States, consumption has generally held up well so far. However, the 30-50% increases in inventory at U.S. flagship retailers such as Walmart and Target suggest demand has moved ahead of what they had hoped for. Persistent and high inflation is an obvious risk to future consumption, further complicating the ability of central banks to tighten policy without slowing growth too much.
In other words, a soft landing seems more tenuous the longer current conditions last. This has resulted in the notable flattening of yield curves in Europe and the fall in US breakevens in recent weeks. Liquidity conditions in fixed income, particularly European credit, have been challenging, although in European investment grade bonds the widening of spreads has been indiscriminate.
Asset class views as of June 7, 2022
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All opinions expressed herein are those of the author as of the date of publication, are based on available information and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice.
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