The central banks strike, interest rate turnaround is definitely here

Chart of the week

The chart shows which inflation figures the market expects until 2024 (blue line). This is the so-called forward curve, which is calculated from futures prices. The gray lines show the monthly estimates since the beginning of 2021.

Why this is important

Since inflation has been rising, the expectation of investors has been "inflation will rise for two more months, then it will peak and start to fall again." Over the past 1.5 years, this forecast has been consistently wrong. The broad market, or the majority, is often wrong. You should do your own analysis and not blindly trust the broad market.

The central banks strike, interest rate turnaround is definitely here

Last week, the ECB, the European Central Bank announced that it would raise interest rates in July. The announcement had a big impact on Italian government bonds:

At the beginning of the year, the interest rate differential between German government bonds and Italian government bonds was around 1%. After the announcement of the ECB's interest rate step, this difference increased again sharply, to over 2%. The dwindling confidence in Italian government bonds means that investors are expecting a comeback of the euro crisis.

The ECB announced this week that it would take a clear stand against this and support Italy with additional funds. This measure received a mixed reception. One set of headlines was "One small wind and the ECB topples over", the other was "Courageous ECB intervention stops euro crisis in its tracks".
We clearly agree with the second headline. Had the ECB not intervened here, a momentum would have been created that could not have been stopped. The market is already busy enough with Covid and the Ukraine crisis. An additional euro crisis would come at a very bad time.

The ECB's announcement to vehemently oppose an emerging euro crisis then gave the Swiss National Bank (SNB) the opportunity to make a surprise interest rate move without the risk of the Swiss franc appreciating too much.
We welcome the interest rate move and the reduction of negative interest rates from -0.75% to -0.5%.

What we do not understand, however, is the SNB's communication policy of surprising all market participants as much as possible. A modern communication policy looks different.

The chart shows the probability with which market participants in the U.S.A. expect another interest rate hike in July. Investors are prepared for the next interest rate hike with press releases, lectures and disclosure of the decision criteria. This is what modern central bank communication looks like, and this is how almost all major central banks are now implementing it.

Only the Swiss central bank still relies on total deception and surprise. At the beginning of the week, only 2 out of 26 experts expected such a move. Even if the interest rate decision is to be welcomed, such communication sends shock waves through the financial markets that are simply unnecessary and only destabilize the markets unnecessarily. The Swiss central bank's communication policy is stuck in the last century. It would be desirable for it to switch to modern communication, as almost all of the world's major central banks have done in the meantime.

The chart shows the change in 30-year mortgage rates in the USA. These have doubled within a very short time! The USA has also raised interest rates further this week. It is already far ahead of Europe and Switzerland in its rate hike cycle.  

The chart should be a warning to European and Swiss homeowners. Fixed mortgage rates will also rise sharply in the coming months. Anyone planning to switch from a Saron mortgage to a fixed-rate mortgage doesn't have much time left.

How much lower can the stock markets go?

Last week we were asked in a customer meeting, how big is the risk for further losses in value on the stock markets, after the already big correction?

Such a question is not easy to answer. One uses scenario analyses and looks for similar points from the past.

The chart shows the development of the broad stock market in the U.S., measured by the S&P 500 from 2006-2009 (blue line) and from 2020 to today (black line). The period of the financial crisis has many parallels to the current market situation. Back then, too, an extraordinary event (collapse of Lehman Brother) shook the markets and consumer confidence dropped rapidly.
It is amazing how parallel the price of the S&P 500 behaved then and now. If things go according to the same script, the markets could fall another 20% after a recovery.
However, we are currently confident and do not think it will come to that. We expect supply chains to normalize and also that a ceasefire in Ukraine is possible in 1-2 months.

How are the big investors positioning themselves now

Bank of America conducts a survey of the largest institutional investors every month. In these Fund Manager Survey (FMS) they ask investors how they are positioned and what they expect in the future. Analysis of this survey is helpful in identifying which direction the largest volumes of analage are flowing and which markets could benefit.

The first question investors were asked was where they see the highest risks. Investors see the greatest risk in central banks that are too aggressive, raise interest rates too much and cause the economy to slide into recession.
In the coming months, how central banks behave will continue to be crucial for the stock market. Their communications and actions should be closely followed.

Here, investors were asked how many more interest rate hikes they expect in the US between now and mid-2023. Most investors expect 8 more rate hikes, some even 10. We think these expectations are exaggerated. We already had negative GDP growth in the U.S. last quarter and consumer confidence is as low as it has been since 2000. We think the economy is already cooling sharply and such strong rate hikes are not necessary.

Investors were also asked whether they expect weaker or stronger growth in the economy in the coming months. The survey results are extremely negative. The last time they were this low was during the financial crisis. It is almost impossible to expect anything worse. Even marginally positive business results from companies could lead to a turnaround and a counter-reaction here.

Investors are also asked every month where they see the "most crowded trend". That is, the investment trend in which everyone is already positioned and which will soon turn around. So anyone still betting on higher oil prices or a higher USD now runs the risk of being the last to get in and making losses.

But let's look to the future. Which trends are the major institutional investors focusing on over the next 12 months? Here, 3 mentions clearly stand out: high-quality equities, value stocks and dividend stocks.

Conclusion:
We think that the markets are currently too negative. We expect a countermovement in both the equity and bond markets. We have then also used the sharply falling prices of last week to reduce the cash holdings in the portfolio and will continue to do so in the current week.