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Investment Outlook: Is risk appetite set to improve?

Gaurav MehraManaging Director and Senior Partner - Head of Macro Trading

Investment Outlook: Is risk appetite set to improve? 

US inflation set to cool?

The US Federal Reserve matched market expectations on 4 May by raising its benchmark interest rate by 50 basis points (or 0.5%) in an effort to stifle the highest levels of inflation in four decades. Fed chair Jerome Powell told investors that policymakers did not discuss accelerating the central bank’s planned rate hike in June to 75 basis points, which prompted a short-lived equity market rally.

Investor sentiment then turned bearish, reflecting fears of an eventual recession as the global economy slows and inflation climbs. That has triggered a series of equity market selloffs and volatile bond markets with 10-year US Treasury bonds yielding more than 3%.

Stalling the rapid rise in consumer prices is one of the Fed’s key tests for successful monetary policy. April’s consumer price index data, released 11 May, is highly anticipated.

In March, driven by energy prices, the annual inflation rate in the US rose by 8.5%, its highest level since 1981. Any reading that shows price increases slowed to 8%, or slightly lower, will be interpreted as a positive sign that prices are stabilizing. Even if inflation remains high, that will reassure markets that consumer prices are at least slowing, and risk appetite should improve.

Equity selloffs mask healthy earnings, valuations are attractive

In the meantime, the US technology sector took the brunt of the equity market’s declines. While the falls in stock markets have been steep, we believe that valuations are now at attractive levels. Based on 12-month forward price-earnings ratios, an investment measure of a firm’s value, valuations on the S&P500 index are approaching 17 times earnings, compared with a spike of 25-times during the pandemic. 

Four-fifths of US listed companies have reported first-quarter earnings, and some 70% of the market in Europe. Of those, around 80% of results have beaten analysts’ Earnings Per Share estimates, and 67% have beaten sales estimates. Earnings in Europe, despite the geopolitical uncertainties surrounding the war in Ukraine, have also been solid.

In addition, as the earnings season for the first three months of 2022 comes to a close, cash-rich companies will start to buy back their own shares, offering some additional support to markets. We suggest in particular watching ‘bellwether’ stocks such as Apple and Microsoft.

Is the dollar poised to peak?

In this ‘risk-off’ environment, investors have treated the US dollar as a haven asset since Russia’s invasion of Ukraine, sending it to its strongest levels in 20 years against a basket of other currencies. If the dollar stabilizes or reverses some of its gains, that will also improve market risk sentiment. The dollar is trading against the euro at levels close to where in July 2012, then European Central Bank President Mario Draghi told markets he would do “whatever it takes” to support the single currency.

Meanwhile, gold is trading at levels around USD 1,850 per ounce. That suggests that the traditional portfolio hedge from inflation is well worth owning.