“Capital markets are in complete disarray and we are detecting structural changes,” said Ewout van Schaick, head of multi assets at NN Investment Partners, talking to InvestmentOfficer.nl in a podcast interview.
“If you had told the average investor at the beginning of the year that the Fed plans to raise interest rates to perhaps 5 per cent, nobody would have taken you seriously,” Van Schaick said, adding that, as a result, he expects that both equities and bonds have not yet seen their market lows.
“The declines in equity markets stem from the inflation problem. Central banks want to tackle that inflation, are raising interest rates and so prices of existing bonds are falling. This has all led to unexpected losses. Especially in defensive portfolios, the losses have been startling,” he said.
Clouded correlation
Equities typically suffer from rising interest rates as they affect earnings expectations. Because there is a higher coupon to be had on bonds at the same time, funds traditionally flow from one asset class to another. When interest rates fall, the opposite happens. However, the traditionally negative correlation between equities and bonds this year has been clouded as both asset classes have come down by double digits.
Nevertheless, Van Schaick believes that equities and bonds are still correlated in the long term. “We have to be realistic, though. Our team has often looked at that correlation and it has always been very unpredictable in the short term. It is dangerous to build on that correlation if you are looking for quick certainty.”
Central banks no longer support stocks
At this time, interest rates are not yet sufficiently discounted in US stock prices. “Many of my colleagues are used to central banks helping equity markets during major declines. That era is probably over. Interest rates will stay high for longer than we always thought.”
European equities, on the other hand, have priced in much more bad news. That is not only to do with interest rates, but also with the poor outlook due to the war in Ukraine and its effect on energy prices, said NN IP’s head of multi-assets.
European equities are also less sensitive to interest rates than US equities. In Europe, you generally have more companies paying good dividends, so a chunk of earnings is a bit closer. He says that helps dampen the negative effects of rising interest rates.
Gas price cap would remove uncertainty
Markets are likely to react positively to the gas price cap now being set at the European level. That wouldl remove uncertainty, he said. The big question is just how major users of gas will react to it. Companies are shutting down parts of their production because that price is rising too fast.
German industry and the stock market are very dependent on the car industry. That industry uses a lot of gas and so a rising price will be able to significantly reduce expected profits. However, the fall in the euro will cushion some of that blow as it strengthens the competitive position, Van Schaick said.
NN Investment Partners is a unit of Goldman Sachs, which completed its acquisition of the Dutch firm in April.