Growth resilient to monetary tightening
The global economy continues to show unexpected resilience. In the United States, growth reached 3.4% in the third quarter, while activity indicators continue to point to an expansion above its long-term trend. Growth in Europe also exceeded expectations, although the outlook remains more uneven across countries. Our central scenario of soft reflation therefore remains unchanged: robust growth combined with inflation that is still too high for central banks to let down their guard.
The rebound in energy prices is nevertheless complicating this picture. It is keeping pressure on corporate costs and could once again weigh on household purchasing power, particularly in Europe. For now, long-term inflation expectations remain well anchored, while tighter financial conditions are helping to contain these pressures. Central banks can therefore afford to be patient, although monetary tightening is likely to continue in December.
The main change is instead the gradual accumulation of risks around this scenario. Higher interest rates are starting to affect the sectors most sensitive to financing costs. The US housingmarket provides the clearest example: high mortgage rates are weighing on housing affordability, while several activity indicators have fallen to low levels. The longer rates remain elevated, the greater the risk that these pressures spread to the broader economy.
The artificial intelligence investment cycle continues to provide significant support to US activity. We are not questioning this growth engine, but markets are becoming more selective. After several years of accelerating investment, investors are paying greater attention to how these expenditures are financed, their impact on cash flows and companies’ ability to generate returns on these investments.
Our scenario therefore remains favourable, but calls for greater caution. As long as growth and earnings remain resilient, we maintain our exposure to risk assets. However, higher interest rates, energy-related pressures and the first signs of widening credit spreads are leading us to gradually increase portfolio diversification.
“High-quality sovereign bonds are once again becoming a credible source of protection against an economic slowdown”
- Valentin Bissat, Chief Economist & Senior Strategist
Rebalancing risks without exiting the market
Equity markets continue to be supported by solid fundamentals. The earnings season remains broadly positive, with earnings growth still driven primarily by technology, communication services and energy. We therefore maintain a neutral exposure to equity risk and our positive bias towards technology. Concerns surrounding the financing of artificial intelligence, together with the recent weakness of some companies that are particularly dependent on capital markets, call for greater selectivity but do not yet challenge the broader theme. At the same time, we continue to reduce some cyclical exposures in favour of selected defensive sectors. Energy retains a particular role in our allocation, as it benefits directly from elevated oil prices while providing protection against renewed inflationary pressures.
Following the sharp rise in bond yields, fixed income once again offers attractive carry and is gradually regaining its diversification role. We have therefore continued to reduce our duration underweight. At current yield levels, high-quality sovereign bonds are once again becoming a credible source of protection against an economic slowdown.
At the same time, the risk-reward profile of credit has become less attractive. After a prolonged period of very tight spreads, their recent widening is a reminder that the asset class offers less protection should growth slow. We have therefore taken profits on part of our high-yield exposure, halving our overweight and reallocating the proceeds to sovereign bonds.
How do we invest?
The resilience of economic growth and solid corporate earnings continue to support our moderate reflation scenario.
• We maintain a neutral exposure to equity risk, with a preference for the United States.
• We maintain our positive bias towards technology and energy.
• We have reduced some cyclical exposures and increased diversification towards more defensive sectors.
• We have halved our high-yield overweight given the risk of a further widening in credit spreads.
• The proceeds have been reallocated to sovereign bonds, where current yields now offer more attractive protection against a potential growth slowdown.
• We maintain our exposure to gold as a source of diversification.
