ABN AMRO MeesPierson: patience required from investors on the road to recession

Although the economy has fared better than previously predicted, tighter monetary policies are expected to trigger a mild recession. This conclusion is presented in ABN AMRO MeesPierson’s Investment Outlook for H2 of 2023, published today under the title ‘Patience is required’ (link).

“The economy has proved to be more resilient than expected,” explains Richard de Groot, Head of ABN AMRO’s Global Investment Centre. “Last December, we predicted that investors would shift their attention from inflation to recession. While that shift is in fact underway, it is taking longer than we thought at the time. The growth rate has slowed down, but the economy is not contracting. The road to recession requires patience from investors – and caution. This warrants a defensive stance in the portfolio, which is why we are more positive about bonds than equities just now.”

Impact of interest rate hikes to make itself felt, though later than expected

ABN AMRO MeesPierson expects to see a considerable slowdown in economic growth during the period ahead. The Private Bank highlights trends in lending: banks are becoming stricter in their lending conditions and the demand for loans is plummeting. These trends hint at a moderate recession, at the minimum, in many developed economies.

The rapid drop in the demand for loans is the first visible sign of the effect of monetary tightening by central banks. Although the end of the rate hikes is near, according to ABN AMRO MeesPierson it could take about a year before the economy feels the full impact of the higher interest rates. Most of the rate hikes came during the second half of last year, and the bank expects H2 of 2023 to be a difficult time for the economy.

What the stock markets have already priced in The stock markets started this year strongly, ABN AMRO MeesPierson notes, buoyed by solid company earnings. In terms of valuations, equities are not cheap at this time, and equity risk premiums (i.e. the additional return over risk-free rates) are too low, particularly in the US. Given the combination of these factors, ABN AMRO MeesPierson believes that the stock markets have not yet entirely priced in the likelihood of a recession.

The bank also believes that consensus views on company earnings are overly hopeful. De Groot explains, “Analysts expect company earnings in the US and emerging markets to recover during H2. That projection is too optimistic, we believe. The tightening monetary policies will have consequences – and both companies and consumers will start feeling those consequences more and more. So we expect company earnings to go down.”

Underweight in equities; preference for defensive sectors

Against this backdrop, ABN AMRO MeesPierson has decided to retain its defensive stance. ABN AMRO MeesPierson is underweight in equities, with a preference within that asset class for the IT industry and defensive sectors such as healthcare. The bank is less positive about financials and consumer discretionary. At the regional level, emerging-market equities are preferred over equities from developed markets.

High-quality bonds to serve as a buffer Where a recession is not entirely priced into the financial markets yet, according to ABN AMRO MeesPierson the inverted yield curve indicates that bond investors are prepared for economic contraction. However, the bank qualifies this by adding that the situation in the bond markets is not entirely consistent: risk premiums on bonds remain tight, which implies that bond investors are not very concerned at this time about downgrades or bankruptcies.

Overall, ABN AMRO MeesPierson is neutral in bonds, although the bank expects bond investors to benefit when inflation diminishes. De Groot continues, “If inflation continues to fall, and interest rates eventually drop, this should be good news for bonds. Within the bond market, we are positive on high-quality bonds, for example the safer government bonds. High-quality bonds offer a buffer during times of great volatility in the financial markets. At the same time, we are more cautious with riskier bonds such as high-yield corporates.”

Currencies: little potential for the euro to climb against the dollarRelative to the current situation, ABN AMRO MeesPierson sees little potential for the euro to climb against the dollar (EUR/USD), and possibly some weakness. Interest rate markets still expect the Federal Reserve to lower interest rates significantly in 2023. However, the private bank does not expect the Fed to begin any monetary easing until the end of the year, and believes that the interest rate cuts for 2023 will largely be priced out by the interest rate markets. This should give the dollar some support. For the long term, however, the EUR/USD trend will remain positive as long as the exchange rate is more than 1.0450, and the bank’s year-end forecast is an exchange rate of 1.10.