The rally has already gone most of its way
The year 2023 is off to a great start for the equity world. But the markets remain in the grip of geopolitics and persistently high inflation on both sides of the Atlantic. Ethenea’s Senior Portfolio Managers explain how the Ethna-funds are positioned for an uncertain backdrop and volatile markets.
“Our base case scenario assumes that the American and European economies slow down, but a technical recession is avoided and the inflation rate remaining sticky,” says Volker Schmidt, Senior Portfolio Manager of Ethenea’s Ethna-DEFENSIV fund, which mainly invests in fixed income markets.
In its updated Economic Outlook, the IMF forecasts growth of 1% in the U.S. and 0,5% in the Eurozone for 2023. The most important reasons for the improving prospects are the reopening of China as well as falling energy prices in Europe. “Despite adverse risks have moderated since October 2022, they remain tilted to the downside”, says Volker Schmidt. “As the central banks seek to navigate a narrow channel towards the soft landing, any deviation from the envisioned path is likely to bring economic struggle.”
On the one hand, a plethora of indicators are pointing to an impending recession in the near future; inverted yield curves, leading indicator indices, and several sectors already seeing a recession such as housing and manufacturing in the U.S. On the other hand, if the Fed’s policy turns out to be not sufficiently restrictive, strong economies will cause central banks to fear that inflation will not crest and fall to 2% and then high (and even higher) rates are likely to stay with us in 2023.
Volker Schmidt : “Therefore, instead of taking greater risks to achieve higher returns, we strive to make the portfolio of the Ethna-DEFENSIV fund resilient and aim for investments that should be able to maintain their values in a possible recession or a tighter monetary policy. With our fairly conservative portfolio as a starting point, we might unwind our defensive positions and increase portfolio duration in the second half of the year if we see economic difficulties resolving. But for the time being we maintain our view that a cautious attitude is appropriate. At the same time, we are looking to selectively allocate funds to attractive new debt issuance without restrictions on maturities.”
Do not chase this rally
After a gloomy 2022 for equities, we witnessed a strong equity recovery since October in the US, Europe, and also Asia. How sustainable is this recovery? Within a short time, many indices have already recovered a large part of the losses of the past year. European indices - such as the DAX or the EURO STOXX 50 - are only about 5% below their all-time highs reached 13 months ago. The more technology-oriented S&P 500, on the other hand, is still missing 15% to reach its all-time highs. Calculated from the respective lows, a remarkable performance was generated on both sides of the Atlantic in only four months.
“Although a recession seems to be avoided economically, growth expectations are still average to the maximum,” says Michael Blümke, Senior Portfolio Manager of Ethenea’s Ethna-AKTIV fund. “Against the backdrop of further declining returns, we believe that many stocks have risen too much and too fast in the short term. Against the expectations, we are again experiencing the so often quoted "Fear Of Missing Out" (FOMO). This rally is by far not sustainable - in the sense of "it will continue in the same way". For example, the P/E ratio of the S&P500 (calculated on expected returns) has already reached a level comparable to the environment identified as expensive directly before the Covid crisis. However, we are comfortable with the idea that we have already seen the lows. With reservation that a bottom is indeed forming in profit expectations, consolidations from this level should be seen as buying rate. We do not advise chasing this rally.”
Preference for US stocks
Michael Blümke favors a specific regional area for his portfolio for the coming weeks/months : “For some time now, we have limited the selection for our equity portfolio exclusively to US stocks. In principle, this approach is questioned on a continuous basis, but despite the current "renaissance" of stocks from the Europe and Asia, there is still no reason to deviate from it. Especially if one considers that the underperformance of the American benchmark index has been caused mainly by the megacaps and their weighting in the index. We continue to focus on large American stocks with a convincing market position.”
Could dividend stocks be a good option in the Ethna-AKTIV portfolio? “Our equity portfolio is a high-quality reflection of the US benchmark index,” says Michael Blümke. “By focusing on high-dividend stocks, we would enter into a style and sector bias, which we do not want. Even if these stocks perform very well in crisis years (such as 2022), they are not as strong in growth in the long term and our approach of being able to hedge the base portfolio with index derivatives at any time without too much base risk would no longer be feasible.”
Flexibility and patience
“Although the overall strategic equity market evaluation has improved since the beginning of 2023, it is still not good,” says Christian Schmitt, Senior Portfolio Manager of Ethenea’s Ethna-DYNAMISCH fund. The current reporting season shows that the economic risks are only slowly materializing. With falling profit expectations and the recent rise in equity prices, valuations – especially in the USA – have increased again significantly.
“We therefore assume that the rally has already gone most of its way. Our bottom-up perspective confirms this view: currently, no particularly attractive entry opportunities are crystallizing in individual single stocks. From a tactical perspective, we are therefore more inclined to reduce the net equity exposure again. Flexibility and patience continue to be important attributes for us.”
