WHAT CAN WE EXPECT IN H2?

Since the beginning of the year, we have seen an increasing divergence between the optimism of the equity markets and the warnings coming from the fixed income segment. Equity markets are rising, corporate earnings have been very resilient, and, at the same time, yield curves are still inverted, which usually signals a recession. So far, the equity market is ignoring the warning signs from the bond markets. Moreover, if we look at market flows and behavioural finance indicators, there are increasing signs of greed and over-optimism. This is another reason for caution.

After the recent equity market rally, equity valuations in the US and Europe appear less attractive. In addition, earnings momentum is slowing somewhat due to high inflation and recessionary risks. Although headline inflation appears to have peaked, core inflation remains stubbornly high. This could force central banks to keep monetary policy tight for longer, which would inevitably weigh on corporate earnings. While companies have shown an impressive ability to weather the current environment, at some point they will have to bear the brunt of the difficult market environment. In conclusion, our analysis suggests that markets remain vulnerable, particularly in light of (1) macroeconomic uncertainties, (2) not cheap equity valuations, (3) low market volatility and (4) overconfident investors.

In this context, we remain slightly underweight in equities to be able to become more aggressive when opportunities arise. Why are we only slightly underweight? First, we favor quality-oriented stocks with low debt, high return on capital, stable margins, and recurring profits. The fundamental downside risk for these companies tends to be limited and transient.

Second, we focus on structural growth areas that can exhibit growth even in economically challenging times. For long-term investors in these high-quality compounders, being in the market and taking advantage of the long-term growth trend is generally more important than being out.

At the same time, we continue to take advantage of the attractive yields on offer in the bond market. We favour investment-grade structures with strong balance sheets and low refinancing needs. These issues offer attractive valuations with low embedded credit risk.

Diversification remains key: Sector diversification with industrials, technology and healthcare names; geographical diversification with European, US and, to a lesser extent, Asian convictions; and asset class diversification with increased decorrelation between equities and bonds. Finally, the presence of gold in the portfolio could also be a source of greater diversification.

REASONS FOR GREATER EXPOSURE TO RISKY ASSETS

Reasons to increase exposure to equities could be: (1) a surprise fall in core inflation (2) a sharp market correction (3) a sharp deterioration in market sentiment (4) and simply the passing of time, as the earnings base of our preferred companies tends to grow over time, making these stocks cheaper even if they trade sideways.