The financial markets face several challenges in the coming months. The Corona pandemic was pushed into the background, also thanks to a less aggressive virus variant. The war in Ukraine and further central bank policy now dominates market activity. Russia’s overall economic importance is small, but Europe is dependent on Russian gas supplies, which cannot be compensated in the short term. Ukraine and Russia are also major producers of wheat or maize with a global market share of over 10%. The surge in energy and food prices reinforce the ascent of consumer prices that started at the turn of the year and increases the pressure on central banks to raise interest rates. The IMF and OECD have revised growth prospects significantly downwards, and Europe in particular faces a significant slowdown, the worst-case scenario being stagflation. Central banks are faced with a dilemma: how much can interest rates be raised to achieve a dampening effect on inflation without jeopardizing growth prospects? While the FED has already announced several rate hikes, the ECB remains hesitant, but it can be assumed that the ECB will end its bond-buying program more quickly and will respond with the first rate hikes in the third quarter.
The bond markets are already anticipating this scenario, interest rates in the 2-10 year range have risen by roughly 100bp since the beginning of the year. Long term german government bonds have lost around 10% since the beginning of the year and are thus only marginally better than equities. Equities tend to perform well in an environment of rising inflation, especially if negative valuation effects stemming from higher interest rates are offset by rising corporate profits. The current reporting season gives cause for hope, but if the assumption of economic growth of more than 2% for Europe still applies; a stagflation scenario is not priced in. For risk-return reasons government and corporate bonds - especially longer dated maturities - remain underweighted, while equities should be relative outperformers in this environment. Convertible bonds appear interesting under these conditions due to their convex character and because interest rates for the typical maturity range (2-4 years) have already priced in a lot.
Author:
Horst Simbürger, MSc, CEFA
Managing Director
CONVERTINVEST Financial Services GmbH
3 May 2022
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Note
Wiener Börse AG would explicitly like to point out that the data and calculations given in this report are historic values, which do not permit any conclusions as regards future developments or value stability. Price fluctuations and loss of capital are possible in securities trading. The contribution is the personal opinion of the analyst and does not constitute a financial analysis or a recommendation for investment by the exchange operating company, Wiener Börse AG.