Vincent Manuel, CIO at Indosuez Wealth Management, discusses with WealthBriefing the macro-economic environment and upcoming opportunities for investors.

Faced with soaring inflation and a significant risk of recession, this week Vincent Manuel from Indosuez Wealth Management, told this publication about investment opportunities for 2022 and beyond.  

The interview took place amidst the publication of a further rise in inflation in Europe in July, and after the Bank of England projected that UK inflation would reach 13 per cent in October and the country would enter into a recession .

“The risk of recession has been rising significantly in the past two months, especially in Europe, on the back of negative household confidence which carry most of the crisis on their shoulders, with lower purchasing power," Manuel said.

“That risk has been amplified by the accelerated monetary normalisation in the US, making it difficult for companies to issue new debt on markets, as well as tensions on energy in Europe,” he continued. “In the upcoming quarters, we are heading for quasi-stagnation in the EU and contraction of GDP and for the next year, growth will be below potential,” he said.

Wealth managers are working out how to frame clients' expectations and set asset allocations at a time when equity and bond markets have both been hit by expected higher interest rates to curb the strongest inflation in 40 years. A common theme is how the old 60/40 equity/bond portfolio split, relied upon to give portfolios balance during difficult periods, is arguably no longer fit for purpose. This partly explains enthusiasm for holding more private market investments, as well as entities such as hedge funds.

Manuel said that in the US, which is less affected by the energy crisis, tighter monetary conditions apply. “The hawkishness of the Fed and the acceleration of rate hikes has had an impact on bond markets and on credit spread. The financial conditions are tightening on companies rapidly, making it difficult for them,” Manuel said.

How fast the Fed can engineer a small recession to dampen down inflation expectations and how much they need to do it to bring down inflation remains to be seen, he said. “The cocktail in the US is somewhat different from the EU, with market-based inflation expectations already starting to diminish there,” he stressed.

Nevertheless, the European Central Bank has accelerated rate hikes recently which he believes is a decision more suited to the current environment than its previous strategy, even if uncertainties remain on the use of the Transmission Protection Instrument.

Going forward, Manuel said that the social and political phase of inflation in Europe has been reached. Governments need to decide how fast wages should be raised, with the risk of engineering a price-wages loop, he explained. "Households are paying for higher food and energy prices and it is only fair to consider an adjustment of wages, or the implementation of energy price shields," he added.

The component of inflation from wages will be key to rising rates at the end of year, he said. But he believes that total inflation will probably be below core inflation next year due to negative base effects on energy. In the longer run, inflation should stabilise at higher levels than in the past at around 2 to 2.5 per cent in Europe, due to a reversal of the impact of structural components such as globalisation, demography and energy models.
 

Positive corporate earnings
“Despite all the negative noise about inflation, an economic slow down and higher rates, corporate earnings are continuing to progress,” he stressed.  “The question is how long can the divergence last? Households are paying the price of the shocks, not companies,” he added. There has been some talk of super taxes on firms but so far this has not progressed.

Investment opportunities
He sees more resilience in healthcare and consumer staples, as well as the B2B sectors and in IT services as companies don’t cut back there.

He recommended investors to cut back on growth stocks and cyclical stocks at the end of 2021. 

Since March, he has been recommending increasing quality, defensive and dividend stocks. Dividend stocks are a good hedge against inflation, he explained. “Our strategy has been to focus on sustainable dividends, healthcare and quality stocks,” he added.

Since the end of May, he has also started to recommend cutting back on value stocks, and increasing quality stocks.

In addition, in mid-June, Manuel decided to increase duration. The increase of long-term bond yields reflects the normalisation narrative of central banks. “From March to May, equity markets were going down and bond yields were going up, causing investors to lose money on both sides,” he explained. “Since the end of May, the recession narrative affected equity markets, with the cyclical sector more affected,” he said. “As we recommended increased duration in June, we have come back to stocks that were affected by higher bond yields, notably profitable technology, which are now posting healthy results. There have also been strong results in healthcare, quality stocks and dividend stocks,” Manuel stressed.