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In recent weeks, inflationary pressures have eased and long-term interest rates have fallen as a result. However, the stock markets have not been impressed by this. On the contrary, the easing of inflation and interest rate pressures is seen as a sure sign that monetary tightening is increasingly reaching the real economy and that corporate earnings could soon come under noticeable pressure. Analysts expect some fragility in corporate profits, but not a significant downturn. So there is a threat of noticeable revisions to earnings estimates. These could be so severe as to more than offset the positive effects of reduced market interest rates on valuations. New drastic sell-offs would be the consequence. Market participants are therefore awaiting further developments.
Three different scenarios appear conceivable for the coming months: In the best case, inflationary pressures ease faster than expected and global central banks return to supporting the markets in terms of interest rates and liquidity. In addition, the global economy is stable and the feared slump in corporate profits does not materialize. However, the macroeconomic leading indicators alone, which point to serious recession risks, argue against this extremely optimistic scenario. It is more likely that the economy will weaken further and corporate earnings forecasts will have to be adjusted downward. In this middle scenario, the stock markets would trend negatively over the next few months. However, the sell-off could be mitigated by a further decline in long-term interest rates in view of the weak macro environment. In a worst-case scenario, a hard macroeconomic stagflation coupled with an earnings recession looms. This could happen if the geopolitical situation were to deteriorate further, for example if the Ukraine war were to escalate and there were a military escalation around the Taiwan issue or in the Iran conflict. There would then be significant slumps on the markets, which could no longer be contained by falling market interest rates or the Fed. In the short term, this negative scenario has only a limited probability. In principle, however, geopolitical disruptive fires are almost certain in the course of 2023 and beyond.
Professional investors should familiarize themselves with the scenarios outlined. In the first half of 2023, a basic defensive approach to asset allocation seems appropriate, but one that leaves sufficient flexibility to benefit from the sometimes friendly interest rate environment. At the same time, hedging against geopolitical risks continues to make sense.