Exposure rates of the Dorval Asset Management Range – July 8th, 2022

The likelihood of the various scenarios on the table for the world economy are changing fast, almost every day, but Europe looks likes the main loser. European investors should perhaps look more to developed Asian markets, rather than the US.

With the obvious major exception of European natural gas, the correction in the price of several commodities (cf. chart 1) is definitely the best news we have heard over recent weeks and offers the most effective solution we can hope for to address the risks of stagflation facing the world economy. The commodities markets are playing their role as automatic stabilizers on the back of rebuilding inventories – particularly for metals – and the prospects of a drop in demand.


The correction in commodities prices is the best remedy for the stagflationary threat
Change in prices YTD, as %


Alongside these positive signals are other signs of moderation, particularly in the US, including the decrease in delivery times in manufacturing, the drop in ocean freight prices, and particularly the slowdown in wage rises to a more sustainable pace at around +4% (cf. chart 2). However, momentum in the services sector remains positive, helping the job market stay buoyant (+381,000 private sector jobs in June). The Fed therefore has no reason to change course for now: the scenario of a US recession in 2022, which had recently gained popularity, still remains highly speculative.


US wage growth seems to be normalizing
Hourly wage, 3-month moving average, annual change over 3 months – median of 12 main sectors


Between recession and overheating, US risks seem to be balancing out. However, on this side of the pond, the financial markets have started pricing in a worst-case scenario, as reflected by the decline in the euro, the dip in bond yields and the clear underperformance from small-caps since the start of June. The Nord Stream gas pipeline will close for maintenance on July 11 and Germany is concerned that it may not reopen: Germany hopes to take delivery of a turbine produced by Siemens in Canada to send to Gazprom and improve gas supplies to the country. However, the fate of gas streams is of course in the hands of the Kremlin. If deliveries resume in late July at the usual pace seen over recent weeks (40% of usual supplies, cf. chart 3), a moderate recession would remain likely in Germany and Italy, but could be avoided in France and Spain. If supplies decrease further, a widespread European recession would become investors’ main scenario, although direct and particularly indirect impacts of this disruption remain extremely difficult to gauge.


Dwindling Russian gas supplies fuel fears of recession in Europe
Millions of cubic meters per day

Usual maintenance in July


What should European investors do in this alarming environment? Despite often highly attractive valuations for European equities, the cash ratio should remain high in portfolios, in our view. Additionally, the so-called home bias must be averted by taking a truly international diversification approach. The dollar and the US markets are the usual safe havens for Europeans, yet they raise a relative valuation problem, with a pricey dollar and Wall Street trading on a P/E multiple five points above the rest of the world. Conversely, developed markets in Asia – Japan, Korea, Australia, Singapore – offer a much more attractive valuation-risk profile, particularly Japan (cf. chart 4), with an extraordinarily inexpensive currency and P/E almost as low as Europe. Additionally, these markets should benefit from the gradual upturn in the Chinese economy after successive dents from real estate and renewed Covid lockdowns.


Japanese equities enjoy attractive valuation and very inexpensive currency

Forward P/E on MSCI Japan
Euro/Yen (inverted scale)


We maintain high cash levels in our flexible portfolios this week. We have increased the weighting of Japanese equities and the yen in our international portfolios, and hedged part of our European exposure via futures. Our bond duration remains close to zero.



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