Investment Viewpoint: staying the course despite the scare

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Markets and macro insights with Sebastian Orsi, CFA, Senior Research Analyst

What happened in financial markets last week?

• Global equities declined about 2% in local currency terms (lc) last week. Once again, markets were dominated by the US administration’s chaotic trade announcements and by responses in kind from trade partners. The news flow is driving a ‘growth scare’. We see this in the equity market pullback and the recent relative performance of less economically sensitive sectors.

• Adding to the worries are statements by US officials to the effect that policy won’t be changed based on market volatility or near-term economic concerns. These comments should be seen less as a guide to future policy than as defences of the credibility of the current approach.

• Worrying trends must be kept in context. Global equities are down only 1% this year, and the current downturn can be observed mainly in the weaker US equity market. The euro area is up 7% year-to-date (ytd) and Asia ex-Japan is slightly positive. The ‘growth scare’ we are experiencing is concentrated in the US. Policy changes elsewhere, in China and (potentially) Germany, will generate economic momentum in their respective regions.

• Returns from international markets have been further depressed by weakness in the US Dollar, and this is related to the US ‘growth scare’. Confidence regarding the US economy has declined. In respect to the other major economies, by contrast, confidence has improved. This ‘growth gap’ in favour of the world ex-USA has the consequence of weakening the US Dollar. A further result of this ‘growth scare’ is a belief that there will be interest rate cuts in the US this year, accompaniced by the view that there will not be any further cuts in the euro area. This yields a smaller interest rate gap in favour of the US Dollar and puts further downward pressure on the exchange rate.

• While the proposed German fiscal package has had a positive impact on euro area equities, as well as on the euro exchange rate, and on the prospects for the euro area economy, the package exerts a negative effect on the euro area bond market. Expectations for more debt issuance from Germany have pushed up euro area yields by 0.5%. Euro area bonds are down about 2% ytd, with the decline occuring just after the fiscal plan was announced this month. Euro area corporate bonds have fared better, down about 0.5%, which is due to the fact that they are typically shorter duration and growth is supportive of credit.

Was there any economic data released last week?

• US inflation data was the main release in an otherwise quiet week on this front. US CPI (Consumer Price Index) data continued to show slowing inflation. CPI rose 2.8% year-on-year (y/y), slightly less than anticipated and down from 3.0% last month. Core CPI (excluding food and energy prices) declined to 3.1% y/y, again a little bit lower than anticipated and down from 3.3% last month. Within the CPI figures, the core services data that the Fed is watching closely decelerated as housing cost growth (owners’ equivalent rent, OER) slowed.

• The inflation data is unlikely to move the US Federal Reserve (the Fed) from its current stance of being on hold. Inflation is slowing as anticipated, but still above target levels while growth remains strong enough.

What should investors do now?

• Market corrections can be unsettling for investors but are not uncommon within uptrends. The current pullbacks have been from very recent highs after strong price increases. The S&P 500 is really the only regional market in correction territory (down 10% from its high), and the year-to-date return is a mid-single-digit percentage decline.

• Policy-related volatility is likely to continue in the near term, but we did get over some hurdles recently. The 2025 economic growth forecasts have been cut in the US as economists attempt to foresee the impact of tariffs and the related uncertainty on consumer and business confidence. Up to now, they have been loath to make such predictions due to a complete lack of clarity. Now they feel confident enough to make such predictions, and we begin to get a sense of the cost of the policies and the uncertainty around them. The result has been to take the outlook to below-trend growth in 2025, rather than materially increasing the probability of recession. We would need to see a substantial slowing in job growth to make us concerned about the risk of a recession. In the meantime, business confidence remains in expansion territory.

• We believe we are in a positive but slowing economic expansion. Such an environment is typically supportive of real asset returns, i.e., rising stock markets. We recognise that expected returns are relatively modest given valuations. In addition, given the cycle’s maturity, we have favoured secular growth regions/sectors/securities over more cyclical elements. While we are now travelling through some volatility, the drivers of that volatility are not expected to fully undermine the growth outlook.

• Earnings revisions remain modest, and the last quarter’s results season was strong both in Europe and the US. It appears that the US consumer was front-loading spending in anticipation of tariffs, so we may see some weakness in consumer-related companies in the first quarter results, starting in three weeks’ time. Just as we have seen economic forecasts being cut, there is some expectation for earnings growth to be cut and hence priced into current market prices.

• Bond yields have risen in the euro area, and if the new fiscal path is confirmed in Germany, they are unlikely to decline much. Capping any further rises in yields is the current weakness in the euro area economy, which we think should bring further interest rate cuts.

• Investment returns have been hampered by a weak US dollar. For the US dollar to weaken more, the US economy must slow down more than expected. Although it may still suffer from short-term volatility, it is unlikely to be a major drag on performance to the end of the year.

• In summary, our top-down view remains unchanged by current policy news flow. Nonetheless, we don’t view the very recent market moves as sufficient to drive tactical changes currently.

The week ahead: what to watch out for

The two main economic indicators pending next week are US retail sales (which were released on Monday, 17 March and showed reasonable strength with +1.0% control group sales growth, albeit with negative revisions to prior months) and the US Federal Reserve meeting on Wednesday. Fed Chair Powell very recently downplayed growth fears, so his commentary will be closely scrutinised. Final euro area CPI figures for February are also due Wednesday.