US rates likely to increase and stay at peak level

The US labour market showed further signs of cooling in June but probably not enough to dissuade the Fed from hiking rates once more, as labour demand still looks strong. Against this backdrop, we expect that the Federal Open Market Committee (FOMC) will prefer to proceed with its plans to raise the federal funds target rate by 25bps later this month. With the US economy seemingly digesting tighter monetary policy quite well, it is looking increasingly likely that interest rates will stay at their peak level for longer. We expect the Fed to hold off on rate cuts until at least March next year.

We believe the best response in the case of the US is to use the recent weakness and lack of stock market breadth year-to-date to pick up individual stocks. For example, our technical analysts see interesting picks in the transportation and logistics business. The fact that transportation stocks triggered medium-term buy signals as of late is noteworthy, since transportation stocks tend to be good leading indicators for the overall economy. This will also be one of the core topics of the upcoming earnings season as of the end of this week.

No massive stimulus package expected in China

China’s economic recovery has been short-lived and has failed to revive confidence. In response to the economic headwinds, policy easing is gaining traction. Since June, policymakers have announced policy support on several fronts, however these measures are increasingly looking like a case of ‘too little, too late’ and expectations for further policy easing have intensified.

The upcoming Politburo meeting at the end of July will therefore be closely watched. On the monetary policy front, further incremental easing is likely to follow in the coming months. Taking the pandemic years as a reference, further rate cuts of 10bps–20bps are possible.

Structural challenges related to excessive debt and overinvestment, and the government’s focus on promoting quality growth, will likely keep overall policy stimulus moderate and targeted, and prevent policymakers from turning to the traditional stimulus playbook involving broad-based housing, construction, and infrastructure-based easing used to boost growth in previous downturns. Given these constraints, the scale and impact of potential stimulus measures are unlikely to boost the economy on a broad basis.

Chinese equities: Opt for stated-owned companies and high dividends

This weaker than expected policy intention in China has resulted in disappointing market performance. Pessimistic investor sentiment and light investor positioning may buffer the market from significant downside, but we think the market will likely be stuck in a trading range with low turnover for the rest of 2023.

Global investors who are looking to recalibrate their China positions may take advantage of any market rebound in the coming weeks due to rising policy expectations. We maintain our preference in the Chinese market for state-owned over private enterprises, and we recommend high-dividend stocks and dividend growers. The internet sector is now cyclical in nature; within the sector, we prefer online gaming and online travel.

Signs of encouragement ahead of the earnings season

Looking at the markets globally, the early indications for the upcoming earnings round are positive, and the odds are good that investors will shrug off a post-pandemic earnings drawdown.

In the US, the Q2 2023 earnings season will officially kick off later this week with several large US banks reporting results. So far, the results of early reporters are encouraging, beating earnings estimates by 3% on aggregate. Moreover, the Bloomberg US economic surprise index currently stands at the highest level since Q3 2020. Analysts have slightly cut their estimates ahead of the start of the earnings season, making the bar to beat lower.

Looking beyond the Q2 numbers, we see two key tailwinds for earnings growth in the second half of this year. First, comparables will get easier: earnings in H1 2022 grew by 10% but only by 1% in H2 2022. Second, the US dollar should shift from being a headwind to being a tailwind in the second half of the year.

The stalling recovery of the Chinese economy poses a headwind, but more so for European equities than for their US counterparts. The share of S&P 500 revenue coming from China is rather limited at approximately 5%. Overall, we recommend staying invested with a focus on quality growth (information technology, communications) coupled with some defensive plays (healthcare, Swiss equities).

Good time to add duration exposure in fixed income

There were also encouraging signs on the fixed income market, with yields at the long end doing a step-up in the first full week of the second half of the year. The 10-year US Treasury yield, a bellwether indicator, crossed the 4% mark again last Thursday and is once again approaching the highs of late last year. However, we would refrain from interpreting too much into the erratic yield developments currently observed and regard current levels as attractive entry points to add some duration exposure if not done already.