German GDP is now poised to contract – unexpectedly – for the second quarter in a row, meaning the country will not manage to avoid a technical recession. The slowdown hasn’t been as sharp as some had expected, but the data do suggest that the surge in energy prices has weighed on the economy, especially given Germany’s dependence on natural gas imports. The economic outlook for the months ahead should brighten following the recent decline in energy prices.
Investor confidence in Chinese equities has been knocked once again, this time because April’s weak economic readings suggest that the country’s recovery might be running out of steam. Other factors, such as the renewed geopolitical tensions with the US, are also keeping investors from returning to that market. Expectations are now extremely low, and a firmer rally is likely at some point this year, once this rough patch is over.
The US consumer confidence index was once again surprisingly upbeat in May thanks to falling inflation and full employment. Households are confident about the resilience of the US economy, which we think will avoid a recession this year on the back of robust consumer spending.
The debt ceiling has unsurprisingly been lifted
The showdown between the White House and the Republican Speaker of the House of Representatives has ended with the debt ceiling being raised (“yet again”, you might add). Of course, the deal struck by the two parties still has to go through Congress. But despite the best efforts of the Republican Party’s hardliners, this should be a formality.
In the end, the negotiations went smoothly and ended early enough to avert any more financial market instability. Only the bond market had started to show a few temporary signs of stress, with very short-term interest rates climbing in the middle of last week. The yield on bonds maturing in early June briefly surpassed 7%, which is well above the US Federal Reserve’s benchmark rate.
A US default has therefore been avoided, and the deal between Democrat President Biden and Republican McCarthy has pushed off further talks for another two years, meaning they won’t happen until after the next presidential election. Although the Biden administration had to make a few concessions by freezing some of its spending, the fiscal impact of the deal should be minimal, and it’s unlikely to tip the world’s largest economy into recession all by itself.
Hopes of a soft landing for the US economy are therefore still alive – output continues to be buoyed by the services sector, with manufacturing expected to start picking up over the next few months, or by early 2024 at the latest. The debt ceiling deal wasn’t struck until the weekend, but the US stock market had already priced in this outcome on Friday, with Wall Street’s flagship index, the S&P 500, closing very close to its YTD highs.
The fading uncertainty should quickly push the S&P 500 index to new recent highs, following in the footsteps of the Nasdaq, which has reached new peaks over the past two weeks.
The bond market should also start to pick up again. The upward pressure on short-term rates has begun to spread to longer-dated paper. Now that investors no longer have to worry about a US default, they should turn their attention back to the fading risk of inflation.
Alternative funds – diversification is still key
Alternative funds have gained around 2% since the start of the year. That performance, plus their very strong resilience during last year’s market downturn, means that alternative funds have fared better than other asset classes over the long term. But their recent trend has caught out some investors, given that stock markets have recorded strong gains so far in 2023.
Long-short equity funds are an obvious source of disappointment, rising just 2%. But this is also because the market lacks depth. It is often said that the biggest tech companies are behind almost all of the rise in stock market indexes. And hedge funds are structurally underexposed to the five biggest tech companies, with an average exposure of 8%, compared with 20% for the indexes as a whole. Managers aren’t short of convictions, which are reflected in their portfolios, but they need broader upside participation to translate these into higher returns.
Event-driven funds have lost ground this year in a still-tough environment, particularly for M&A arbitrage. Regulators have blocked some major transactions, such as Microsoft’s takeover of Activision. The politicisation of certain decisions has made investors more cautious, causing spreads to widen across the board.
At the opposite end of the spectrum, volatility arbitrage funds are faring very well, continuing the trend recorded in 2022. Large inflows into short-dated options and the variable correlation between market direction and volatility are still attractive ways for investors to generate returns without having to take bets on how indexes will perform.
Dispersion between and within strategies therefore remains high, so we continue to recommend taking a diversified approach to alternative funds, which remain an attractive source of medium-term returns with moderate risk.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
