News

Laurent Denize – Global Co-CIO ODDO BHF

A new era

The 2022/2023 period has marked a turning point for interest rates. The era of cheap money that prevailed from 2009 to 2021 is behind us. Neither a prolonged zero interest rate policy nor the sustained use of quantitative easing as a monetary policy tool are likely to be reinstated in the next recession. Interest rates are likely to be much higher on average over the next decade than they were during the last.

Good news or bad news?

The full impact of tighter financial conditions on the economy has yet to be felt. In a worst-case scenario, which we do not favour, rising interest rates could have three consequences:

1. A debt crisis in the real estate sector. Rising borrowing costs could destabilise the sector at a time when property values and debt ratios are excessively high.

2. A sovereign debt crisis in the US or Europe if GDP growth falls below debt servicing costs.

3. Structural stagnation or significant currency depreciation in regions where the private sector is highly indebted, along with a permanent decline in the valuation of risky assets.

However, there is also positive news following this period of “annuitant/rentier euthanasia”. Finally, it is possible to build diversified portfolios with return prospects that could range between 4% and 10% in 2024 by leveraging simple asset classes such as equities and bonds.

The renowned "60/40" (60% equities / 40% bonds) strategy is back, as this type of portfolio will once again provide stability in all market conditions.

The 60/40 strategy in different market scenarios

Recession scenario

Assessing the extent of the slowdown in both the US and Europe remains challenging. While a recession in the US and the eurozone has been delayed this year, it may not be altogether avoided. Developed markets will not be able to benefit from a strong fiscal stimulus this time around unless monetary policy eases significantly. In a more pronounced economic slowdown, the risk/return ratio would be less favourable for equities. On the other hand, bonds could yield capital gains through the carry trade and lower interest rates, which could more than offset the poor performance of equities. This is not our preferred scenario. 

No landing scenario

Conversely, a "no landing" scenario would be favourable for equity indices but could force central banks to hold back. In such a scenario, bond performance could disappoint, but this would be offset by a re-rating of equities, which are currently trading below historical averages. This is not our preferred scenario.

Soft landing scenario

This is our preferred scenario. A slowdown without a marked recession would allow central banks to cut rates without the economy suffering a major setback.

Both bonds and equities could benefit from such a scenario, delivering double-digit returns.

Which positioning to adopt?

Equities: Favour the sector-based approach, be selective about cyclical stocks

Regardless of the region or the economic cycle, the aim is to identify sectors and, within those sectors, companies capable of creating long-term value. However, given the less favourable macroeconomic environment, we favor sectors whose cash flows are less sensitive to cycles.

We favour the healthcare and consumer sectors. We are reducing our exposure to cyclical stocks after their strong outperformance over the past year. These are currently trading at a premium of around 10% to defensive stocks, which is higher than their historical average, while earnings are expected to ease. We are taking profits on semiconductors but continue to overweight AI-driven stocks. In that respect, Microsoft and Google could continue to outperform thanks to their overwhelming lead and investment capacity compared to competitors.

Industries such as chemicals, steel, and pulp/paper are among the sectors most sensitive to economic cycles. As mentioned above, taking positions in these sectors may not be advisable at this time. Yet, counter-intuitively, recent quarterly publications have shown that many of these companies expect their sales to stabilise.

Today, some cyclical companies are showing valuations that already incorporate a severe macroeconomic scenario, similar to those observed in latest phases of economic contraction. The basic materials sector serves as a notable example, and it is starting to re-enter our portfolios. Finally, we are strongly reweighting luxury goods equities following the recent fall in stock prices. Organic growth is outstripping nominal growth and valuations look affordable, in a context where barriers to entry have never been so high. This leads us to consider luxury stocks as a core holding.

Bonds: increase duration, favour high-yield credit

As of November 2022, we overweighted high-yield bonds, believing that the potential returns largely outweighed the associated risks. We are maintaining this conviction while refocusing on maturities of 2 to 5 years. We remain exposed to German and US government bonds, as they should benefit strongly from central bank rate cuts in the second half of the year. But rather than choosing short maturities to capture carry, which was the prevailing strategy in 2023, we are opting for longer maturities with a view to maximising potential capital gains if rates fall.

Currencies: exposure to the yen

We had exposed portfolios to the Japanese yen (JPY) in September 2023. A little early, admittedly, but it is always difficult to predict the exact moment when the Bank of Japan (BOJ) will change its monetary policy. However, such a shift is closer than ever, and it is one of our strong recommendations for 2024. This exposure also allows us to diversify risk in the event of an exogenous crisis.

I look forward to seeing you in January 2024 when we set out our investment strategy. We will be exploring segments such as artificial intelligence, obesity, healthcare and clean tech.

Meanwhile, I wish you a very happy festive season. It's time to celebrate this wonderful year on the stock market. Tomorrow is another day...

Disclaimer

This document has been prepared by ODDO BHF for information purposes only. It does not create any obligations on the part of ODDO BHF. The opinions expressed in this document correspond to the market expectations of ODDO BHF at the time of publication. They may change according to market conditions and ODDO BHF cannot be held contractually responsible for them. Any references to single stocks have been included for illustrative purposes only. Before investing in any asset class, it is strongly recommended that potential investors make detailed enquiries about the risks to which these asset classes are exposed, in particular the risk of capital loss. 

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