Raiffeisen Research: Turning point on the capital market and the ECB

"The Eurozone faces at best a moderate technical recession in the winter half year 2022/2023 and at most zero growth over 2023 as a whole. The risks are to the downside and difficult to calculate. Investors are currently avoiding European macro risk," says Gunter Deuber (Head of Raiffeisen Research). Only when there is more clarity here, then, according to the market assessment of Raiffeisen Research, more investor confidence in European assets can be expected again. The weak quotation of the euro against the dollar as well as the fact that Germany is again considered the economically "sick man" of Europe are a reflection of the hesitant investor attitude towards Europe.

Furthermore, there are increasing indications that the inflation dynamics in Europe and Austria are hardening. Raiffeisen Research forecasts macroeconomic inflation rates (consumer price index) for the euro area and Austria at levels of 8% (2022), 6% (2023) and above 3% (2024). The ECB inflation target is seen as out of reach in the medium term. Core inflation (excluding energy and food) could rise again next year from 4 % to over 5 %, although the peak in consumer prices could be reached in 2022. Gunter Deuber emphasizes, "We are currently experiencing a price level increase of 20 percentage points within a few years. Previously, this took a decade or from 2009 to 2019." Raiffeisen Research thus sees maintaining purchasing power on the capital market as a challenging task.

In recent years, ECB pursued a particularly comprehensive (banking market) management, the central bank has been deliberately active in numerous financial market and capital market segments. Gunter Deuber explains, "The balance sheet total in relation to economic strength has increased significantly more at the ECB than at the Fed, for example. This raises the need for an orderly and well-calibrated exit from unconventional monetary policy." Deuber sees a high degree of market uncertainty, as it appears that the ECB currently remains deliberately unclear in communicating its strategy. However, this means that the volatility of yields in Europe is much more pronounced than in the US capital market, for example. However, Raiffeisen Research sees the ECB's current focus on a "robust inflation control mandate" and its "return" to its roots in the predecessor institution Deutsche Bundesbank as clearly positive and without alternative. Nevertheless, Gunter Deuber considers a stronger focus on the orderly unwinding of the extensive market distortions necessary.

Almost unprecedented in history is the development on the fixed income markets this year. "Bonds in general and also 'safe government bonds' are posting high double-digit market value losses this year. These are losses of a similar magnitude to those on the equity markets," says Jörg Bayer (Head of Fixed Income & ESG). For him, it is a rarity that so-called "safe havens" such as German government bonds cannot live up to their name.

In line with Gunter Deuber, Jörg Bayer links the severe market corrections in the fixed-interest securities sector to the extensive effects of the ECB's particularly expansive unconventional monetary policy. "In contrast to the US, zero and negative interest rates have become the new normal in the euro area over the past decade. Due to the long duration of this state, fewer and fewer market participants have planned for a trend reversal," says Jörg Bayer. This is precisely the reason for the radical upheaval in the bond market. The turnaround in interest rates took place at a historically low level (negative interest rates). Thus, the multiplier (duration) is much stronger and, in addition, due to inflation, interest rate hikes have to be pronounced and implemented in a timely manner, which has the most significant impact especially on bonds with the highest credit rating.

In light of the "normalization in a rush" and the resulting new reality on the capital market, Raiffeisen Research sees opportunities in the fixed-interest investment spectrum again. Jörg Bayer sees the normalization of yields as already very far advanced. "The idea of the dividend as the 'new interest' has had its day. There is a decent yield on the European corporate bond market again," says the expert. At current levels, Raiffeisen Research sees bonds not only as an alternative in the medium term, but even as the first option. This is because both alternative investments (incl. real estate) and equities are likely to be significantly more affected by the current turnaround in monetary policy and the capital market in the medium term.

The international stock markets lost substantial ground this year. "The double strike of geopolitics due to the Ukraine war and the new monetary reality, which also led to a revaluation of shares, was responsible for the price declines," says Christian Hinterwallner (Head of Equity Analysis). It was noticeable that almost all regions – whether industrialized nations or emerging markets – recorded price losses since the beginning of the year. On the sector side, energy was the only positive outlier, as it benefited from the strong oil price.

"As the Fed, like other important central banks, will currently continue to place inflation risks above growth risks, we can continue to expect 'Powell Pain' on the stock markets in the short term," explains Christian Hinterwallner. Furthermore, Raiffeisen Research expects a need for revision with regard to the earnings growth estimates for 2023: these have held up surprisingly well this year, especially in Europe, due to the weakness of the euro, bubbling profits at energy companies and high pricing power. However, as companies are facing higher energy, labor and financing costs and random profit taxes on utilities and energy stocks, experts expect increased pressure on margins in 2023.

Despite the continuing difficult environment in the short term, Hinterwallner says further setbacks would also open up opportunities again, "It should not be overlooked that the price declines of this year already reflect an increased probability of recession. For example, the S&P 500 has already lost more than 25 % from high to low, which is insignificantly less than the average decline of the US leading index in the last ten recessions. In addition, the setbacks have brought valuations back to much more moderate levels and market sentiment is as bad as it was during the financial market and covid crises. This forms some downside protection.

"Hinterwallner sees "the end of monetary tightening and a stabilization in economic indicators in 2023" as triggers for a resilient bottom, which should be followed by a recovery in the equity markets as in the historical pattern. In terms of regional weightings, Raiffeisen Research expects European equities to clearly lag behind their US counterparts due to their geopolitical exposure and the much more problematic economic and inflation environment.

In general, Raiffeisen Research sees an end to the demand-driven equity market exaggerations of recent years and expects a healthier and more balanced investment environment. The times of significant "excess returns" of the stock markets compared to other asset classes (fixed income, government bonds plus money market) should come to an end for the time being. Raiffeisen Research also sees particular opportunities again in the (local) currency bond markets in Central Europe. "The central banks in Central and Eastern Europe have had to make an even more decisive monetary policy turnaround than the ECB or Fed. The average key interest rate here is currently over 8 per cent," says Gunter Deuber. The head of Raiffeisen Research does not expect any rapid interest rate cuts in the region in the coming months. "The combination of high current interest rates plus the prospect that interest rate levels in Eastern Europe will approach those in Western Europe again in the medium and long term, however, should open up strategic opportunities for investors in fixed-interest securities," says the Raiffeisen expert.