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INVESTMENT STRATEGY

15.09.2022

[Podcast's script]

Welcome to ODDO BHF’s investment strategy podcast

Let’s start with the economic outlook, with you, Bruno Cavalier, and this first question: Have we, at last, reached the much-awaited peak in inflation?
I believe the answer is yes in the US and no in Europe. The difference is due to the underlying causes of the inflation shock. The first of these causes is Covid. Remember that, all of a sudden, we shut down the economy, then opened everything back up, and then again, shut everything down and reopened it. This came with stimulus policies that boosted demand, but, of course, supply couldn’t keep up with demand. This resulted in shortages, and pricing pressures. On this front there has been an improvement recently. The second cause – and one that is still with us today – is, of course, the energy crisis, which is obviously hitting Europe the most, owing to its tug of war with Russia. As a result, natural gas and electricity prices have recently skyrocketed to 10, 15 or 20 times their normal levels. Although measures are being taken to mitigate the impact on consumers, the energy crisis is far from over, and that’s why, in my view, inflation should continue to rise in the coming months.

Is a recession now inevitable in Europe?

To answer this question, we first have to look at the current economic situation and the risks that lie before us. What is the economic situation in Europe as summer 2022 draws to a close? Households are having a hard time because of the almost unprecedented negative shock to purchasing power. Second, companies are also being hit by higher costs, even as foreign demand is slowing, in particular from China. And, lastly, banks have taken a cautious approach since the war began in Ukraine, reining in credit conditions drastically. As a result, the business climate has worsened constantly over the past six months. As for the risks, there are two main ones, both downside. First, there’s the energy crisis, which I don’t think requires any elaboration. It’s what’s on everyone’s mind now. Second, we are in the midst of a very aggressive tightening in monetary policy, whose effects, obviously, have not shown up fully in the economy. I expect economic activity to inevitably contract over the coming quarters. In other words, we’re looking at a recession.

One last question: Is the European Central Bank right to tighten its monetary policy?

The ECB’s job is to ensure 2% medium-term inflation. We are now close to 10%. At best, we will be at 5% next year. So, the most orthodox view is that we are far off the target and that interest rates must be raised at any cost. However, the reality is a little more complex. First of all, the inflation shock in Europe has little to do with demand. It has mainly to do with supply-side issues and the energy crisis, and the ECB can raise rates as much as it wants, but that’s not going to smooth out global trade and it’s not going to make it any easier to generate electricity. Moreover, the ECB knows very well that it has no direct influence on prices, and I believe that’s where the battle against inflation is fought. So, the goal is less to bring down inflation quickly than to ensure that inflation expectations – what households expect prices to be in the next two to five years – stay very low. Of course, to do so, some sacrifices will be needed. To paraphrase the ECB, some growth will have to be sacrificed to ensure that inflation comes back down.

Let’s move on to investment strategy with you, Laurent Denize, and this first question: what is the best strategy in European equities?

Based solely on the macroeconomic picture, we would indeed tend to sell European equities. But that’s not what I’m advising you to do today, because asset allocation is actually based on three parameters. First, the micro economy, which – let’s come out and say it – is clearly holding up for the moment. Earnings have been surprisingly good. We therefore expect earnings forecasts to be revised downwards, but maybe not by an alarming amount.  And, third, investor flows have not yet returned, but we could see some catching up if the situation stabilises. So, ultimately, a stabilisation. In any case, it is too late to sell. Better to buy constructively into any further market weakness to add to exposure. Current valuations justify taking on long-term exposure. Meanwhile, volatility is extreme and must be accounted for.

What is your view of high yield?

Counterintuitively and with the euro zone entering into recession, we are rather bullish on high yield. We see two scenarios:
The first is a moderate recession, in which case current spreads seem to remunerate risk properly. Why? Because the probability of positive performance one year forward is 85%, with yields historically estimated at 8%. 
The second scenario is that the situation will worsen. And therein lies the beauty of this product. It has a cushion that we call “carry”, which allows you to offset the loss of principal and, most importantly, allows you to add exposure at far higher levels with potential returns estimated at more than 20%. So high yield looks quite attractive at the moment and we highly recommend it.

One last thing: What are some good ways now to diversify portfolios?

A very good question when you look at the -15% year-to-date performance of a blend of equities and bonds. 
Here are three ways. The first is private equity, which is structurally decorrelated and which currently offers quite remarkable returns. The second is foreign currencies, particularly the safe havens of the US dollar and Swiss franc, which help you limit downside portfolio risk if the markets stay risk-off. And the third is exposure that is slightly less linked to the market in the short term and a little more strategic, i.e., exposure to global themes and long-term trends. I see three of these: the ecological transition, the food revolution and security/cybersecurity. Flows are still positive and seem to bear out our tendency to be exposed to this theme.

Thank you, everyone, for listening. See you soon for the next podcast on ODDO BHF’s investment strategies.

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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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