Inflation is a persistent phenomenon. The central banks of the major industrial nations recently had to learn this old lesson again. Those who had hoped that inflation would automatically return to its target after the coronavirus pandemic and the energy price shock were disappointed. In the USA, inflation now stands at over 4 percent again. By contrast, the inflation target is at or below 2 percent.
The latest increase isn’t solely due to higher energy prices caused by the war in Iran. Core inflation adjusted for these factors also rose by 0.5 percent to 2.9 percent in the USA over the past six months. In the UK and the eurozone, it stands at 2.5 percent. As such, even a lasting ceasefire won’t lead to much lower inflation within the target. It’s not just the US Federal Reserve that’s under pressure. European central banks have already started raising interest rates.
However, higher interest rates are toxic for the equity markets. The latter have performed strongly so far, but have grown increasingly volatile in recent weeks. On the one hand, there are promises of new technologies. On the other, it’s clear that rising prices are a rather unlikely scenario when interest rates rise.
Greater volatility on the stock markets is also due to the fact that expectations for corporate earnings are already impressively high. To illustrate the point: the US IT companies Broadcom and Oracle both reported excellent results for the first quarter, but this triggered sharp price losses on the stock markets. Broadcom is over 20 percent below its recent high, while Oracle is over 30 percent below its peak.
It means we need to be all the more cautious about the performance of emerging market equities, as tech companies dominate the stock markets and price gains have been enormous. Emerging market equities (excluding China), which we overweighted, have already climbed by 40 percent this year. That’s a multiple of the return on US equities this year – reason enough to take profits for once.
One of our other tactical overweights also performed strongly: equity investments in value stocks outperformed the broad US market. That sounds unusual, but tech firms outside the US have actually made up significant ground in recent months, with solid valuation numbers. We also want to take profits here. With both recommendations, we’re moving closer to our neutral strategy, although we aim to remain cautious overall and continue to take less account of the US market than usual.
Finally, there was one development in the tech sector that made us sit up and take notice. The US AI company Anthropic is now prohibited from allowing foreigners to use its best models. This even affects the company’s own employees. It means friends and foes alike are excluded from the greatest advances in technology without distinction, which of course limits potential.
That said, it’s perhaps also a wake-up call for many countries to finally address digital sovereignty. Hopefully for Switzerland, too.
