This summer has once again brought home to us just how vulnerable our world has become. Across much of Europe, weeks and weeks of exceptionally high temperatures have led to drought, water shortages and serious forest fires. Agriculture has also been pushed towards its limits, not least because of the shortage of animal feed. In Switzerland, record temperatures and an unusually long drought have taken a heavy toll our soil, water and farming. Then there’s the war in the Middle East, which drags on despite repeated hopes for progress in the peace negotiations, continues to disrupt key trade routes and is keeping energy prices significantly higher than they were just a few months ago. Meanwhile, the world order continues to fragment.
Many of these challenges will still be with us well beyond this summer. For financial markets, however, the risks alone do not paint the full picture. Just as important is how the economy, companies and consumers respond to them. And here, what we’ve seen over the past few months has been striking.
Although higher energy prices may be weighing on purchasing power and global economic growth has slowed, the global economy continues to tick along steadily, albeit at a slightly slower pace. Even the Asian emerging economies, which are particularly exposed to the conflict and disrupted trade routes, are proving resilient.
These trends are evident in particular in the USA. The economy there has grown by just 0.3 percent on average over the past three quarters – less than half the rate seen in previous years. Yet, any talk of a slump would be mistaken, if nothing else because of the fact that companies continue to be confident. They’re continuing to invest heavily, particularly in artificial intelligence.
The slower pace of growth also has a stabilizing effect. Following the strong recovery in the wake of the COVID-19 pandemic, underpinned by fiscal policy, the US economy has long been operating close to its capacity limits. This pressure is now easing as a result of slightly weaker demand, and this can also be seen in inflation. Over the past two months, core inflation, which excludes volatile energy and food prices, has fallen from 2.9 to 2.5 percent.
This is giving the US Federal Reserve greater leeway, despite higher energy prices, and easing the pressure to implement countermeasures in the form of higher interest rates. The likelihood of interest rate hikes has fallen significantly. At the same time, there are currently few signs of any recession. Although the US economy has slowed down, it continues to be robust. And as long as the economy doesn’t slip into recession, expectations of lower interest rates are essentially good news for the stock markets. The latest developments on the US stock market dovetail with this more positive picture: share price gains are now being driven by a wider range of companies, and are no longer concentrated exclusively on the “magnificent seven”. Corporate earnings are also seeing solid growth, and in some cases even cheaper valuations.
It means the picture is more balanced overall than the headlines might suggest on the face of it. At the same time, given the numerous conflicting factors at play, future financial market performance remains difficult to predict. For us, these are arguments in favour of moving closer to our long-term strategy. With this in mind, we’re closing our underweight in US equities and readopting a neutral position in equities overall. We’re continuing to take account of the ongoing geopolitical risks by maintaining our overweight in gold as a hedge. Swiss real estate also remains overweighted.
