A cloudy summer

Investors have experienced generally low returns so far this year, due to the clouds currently gathering on the horizon, and the approach to risk assets is being characterised by increased caution. This attitude has led to weaker equity markets, wider corporate spreads, and some areas of stress in EM (especially in local currencies).

We can identify different fronts that need to be monitored closely in the short to medium term: the evolution of the cycle and potential regime shift, geopolitical issues, and EM anxieties. First, in order to identify a potential regime shift, it is crucial to understand the evolution of the cycle. In the current phase, on the one side, there is an extended cycle in the US and an upward trend in earnings; on the other, however, we are seeing signs of a maturing cycle: global growth looks to be peaking and inflation is rising gently; global liquidity is expected to diminish and leverage is creeping up. In the current environment, central banks are continuing to withdraw their stimulus, with different speeds of adjustment (further divergences emerged between the Fed and the ECB at their most recent meetings). CBs are no longer responding to any bout of volatility and they are not providing umbrellas against political storms. Geopolitical risks are a second sphere of uncertainty. Disagreements within the EU are assuming harsher tones. The escalation of trade disputes are a nuisance (see US vs China but also vs Canada, Europe). Political issues are also weighing on some EM (elections in Brazil, Mexico and Colombia). Idiosyncratic risks (Turkey) add fuel to EM stress, already challenged by higher US rates and the stronger USD. China’s resilience becomes essential in this context …