The anticipated European recession at the start of the year, as well as a worsened energy crisis, did not materialise. Fresh energy sources were created, along with lower consumption and aided by a mild winter. “This results in cautious economic optimism”, Gerlinger points out. The confidence is bolstered by dramatically lower energy prices, lately higher-than-expected corporate profits, and a marked improvement in supply chains.

The US economy has also managed to avoid a recession to date, and the labour market is solid. In China, the world’s largest economy, the turnaround in Covid policy is contributing to a return to normalcy, which is supporting the domestic economy in particular. Yet, not all is rosy. “M1 money supply is contracting. At the same time, the yield spread between long-term and short-term paper in the US is at its lowest level in 40 years”, Gerlinger adds. Whether a recession is impending, when it will occur and how severe it would be, however, is difficult to forecast because the distortions caused by the corona pandemic are still too serious.

The hike in interest rates has not yet materially slowed the economy. Only highly interest-sensitive industries, such as the real property sector, have experienced increased financing costs thus far. The central banks on both sides of the Atlantic, though, will continue to tighten the screws. Despite the fact that the easing of energy prices is lowering inflation, the core inflation rate (excluding energy and food prices) remains persistently high. Consumer price inflation in the eurozone, for example, had already peaked in October at 10.6 per cent. By contrast, the core inflation rate hit a new record high of 5.6 per cent in February.

“Even if inflation declines in the coming months, central banks’ inflation targets remain unreasonable”, Gerlinger explains. Rates are more likely to be four to five per cent, rather than the aim of just under two per cent. This suggests that more interest rate hikes are likely, which will dampen the economy while also putting additional pressure on the stock markets.

In recent weeks, there has been a shift in favourites. The US market, which had been quite strong for a long time, has recently underperformed, and the interest rate environment has weighed on growth stocks, particularly in the technology sector. Overall, prices are down, but remain above the long-term average. “With a deteriorating economy, profit forecasts in the US are likely to be poorer this year, which could further reduce valuations, some of which are excessive.”

The European market has recently outperformed. The notoriously cyclical industrial sector, in particular, benefitted from the considerable drop in energy costs and improved economic indicators. Rising interest rates benefitted the financial sector. “Europe’s outperformance is likely to continue for the time being”, Gerlinger says. This is because, despite the current rebound, European shares continue to trade at a significant discount to the US market. Also, China’s shift in Covid policy should benefit export-heavy European equities.

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