So far, the erratic actions of the US government have not significantly harmed companies. Firms are focusing on their business. However, the question now arises whether the high US budget deficit will be the next factor to unsettle the markets. We expect the "Bond Vigilantes" and the Federal Reserve to counter this threat.
Author: Stefano Zoffoli
Politics continues to dominate the headlines. New announcements keep posing hurdles for financial markets. Nevertheless, we note that corporate profits have hardly been affected so far (first quarter year-on-year: USA +12%, Europe +4%). But how long can companies hold out? Surveys of consumers and firms, known as Soft Data, already indicate a downturn. In contrast, the hard economic data ("Hard Data"), especially in the USA, show continued robust activity, partly due to advanced spending or inventory buildup.
Overall, we expect a slower growth rate in the USA, but households and firms are too lightly indebted for a recession. Until this scenario materializes, increased price fluctuations are likely after the return to stock market highs. Therefore, we maintain a balanced equity allocation in our strategy.
In the short term, another risk factor needs to be considered: Will the high US budget deficit be the next to unsettle the markets? The outcome of the first showdown between the stock markets and the US administration, following its tariff announcements last April, was in favor of investors. Now, the "Bond Vigilantes" and rating agencies have expressed their discomfort with the US fiscal policy by raising yields on 10-year US Treasury bonds to 4.5% and downgrading the rating to Aa. The second showdown again suggests an advantage for the financial markets. We see opportunities at this yield level, which has rarely been above inflation in the past (see chart below). We particularly prefer UK and Australian government bonds. They have been influenced by the US but have advantages in terms of inflation and public finances of their issuers. Finally, we expect moderate inflation and falling interest rates. This also applies to emerging market bonds, which we continue to favor. However, we believe the price potential of corporate bonds is minimal after the return of credit premiums to around 100 basis points.
We view emerging market equities positively. However, the overrepresentation of Asia appears problematic from a geopolitical perspective. Nevertheless, the countries (China-India, Taiwan-South Korea) complement each other in terms of their economic and political positions. An undisputed plus is the large Asian domestic market, which reduces dependence on the USA.
At the sector level, the position in pharmaceutical stocks suffered significantly last May. We estimate that the political price pressure on the industry will ease somewhat for now and high profitability will come back into focus. As a counterbalance, US Big Tech stands out with robust margins rather than growth. Therefore, we do not expect another outperformance like in 2024.
Despite high interest rates, the geopolitical and economic course of the USA puts pressure on the USD. We consider the strengthening of the "Greenback" after the roughly 11% drop last April to be only temporary. Typically, gold would benefit. Given the extraordinary rise in the first four months of the year, the price has consolidated since May. Therefore, a new entry point for the precious metal could emerge. In general, commodities are not struggling despite falling energy prices. There is evidently a shortage in other areas, so we are reducing the underweight despite the economic slowdown.
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