Exposure rates of the Dorval Asset Management Range – 17th June 2022

With share indices wiping out their 2021 gains (cf. chart 1) and the bond markets experiencing their biggest correction in history (cf. chart 2), investors are quite rightly wondering whether the financial markets have consolidated sufficiently for them to go back in the water. There is both good news and bad in this respect.

Main world stock-markets have wiped out 2021 gains

Stoxx 600 index / S&P 500 index / MSCI World All Country (without currency risk)

 

Bond crash of epic proportion

Max drawdown for the Bloomberg US Treasury index

 

Let’s take a look at the good news first. The correction in equity market valuations now paves the way for opportunities for stock-pickers taking the long view. Looking at economic stats, the moderation scenario is gaining ground again after the hit from US inflation figures in May. Building permits in the US have shed 10% since their high in late 2021. However, confidence in the real estate sector still remains high if we look at the home builders index, the NAHB, which came out at 67 in June, more or less on a par with figures during the real estate boom in 2003-2005. We are also seeing moderation on retail sales (-0.3% in May) largely as a result of a 3.5% dip in vehicle sales. Manufacturing sector surveys by regional Federal Reserve banks at the start of June also confirm that supply pressure is reducing (cf. chart 3).

 

Pressure across supply chains is easing

Delivery times – Philadelphia Fed survey / Delivery times – New York Fed survey

 

Another piece of good news is the ECB’s successful moves to take back control over yield spreads between peripheral countries and Germany as it announced the forthcoming implementation of an anti-fragmentation tool after an emergency meeting, although it did not give many practical details at this stage. The spread between the Italian BTP and the German Bund narrowed from 240bps to 189bps in the space of just a few days: the Governor of the Bank of Italy, Ignazio Visco, suggested that a spread of 150bps would be justified by the fundamentals in his view.

 

Looking now to the not-so-good news, pressure surrounding oil and gas is not dwindling. Despite fears of recession, crude oil prices remain very lofty, with Brent above $120, probably driven by the expected recovery in Chinese demand and the tourist season in developed countries. Gas prices are rising sharply as a result of the drastic cut in deliveries, particularly to Germany via the Nord Stream pipeline (cf. chart 4).

 

Russian natural gas imports via gas pipelines

 

Lastly, the Federal Reserve hiked its rates by 75bps, which is 25bps more than Jerome Powell indicated a mere two weeks ago. Investors are now expecting the federal funds rate to come to 3.5% at the end of the year and a maximum of 3.75% in the first quarter of 2023. In the short term, these more aggressive projections better shelter the market from fresh severe rate hikes. However, in the medium term, we will need to ensure that core inflation follows the fairly optimistic path that the Fed and the economists’ consensus expect (cf. chart 5): otherwise much higher rates will be needed to put the brakes on inflation. Risk premia on rates are therefore perhaps not yet sufficient given uncertainty on future growth and inflation.

 

Optimistic consensus on the drop in inflation in the US

US Core PCE (YoY%) / Consensus projection for 2023 – US Core PCE (YoY%)

 

In light of rising oil and natural gas prices over the past two weeks, along with climbing inflationary pressure in the US and Europe, we have trimmed our equity exposure rates in our international and European flexible portfolios. We will pursue our very nimble approach to adapting our exposure rates in line with our economic and market analysis.

 

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