Markets Update Juli 2023 - Joy over easing inflation could be premature

Declining inflation rates in the USA have recently boosted the stock markets. The markets had hoped for an easing of price pressure, because this would make an end to interest rate hikes more likely. In this respect, the relief that inflation is on the decline is understandable. If this trend continues in the coming months, it should give the markets further impetus for the time being. However, it is easy to forget that disinflation is not automatically good for the stock markets. If, for example, inflation falls because demand collapses due to a sharp downturn, the markets usually react negatively. Such an example of "bad disinflation" can currently be observed in China. Admittedly, the country's economy is still far from contracting. However, the current gloom in the macro data comes very close to a recession by Chinese standards. Despite a decline in inflation and partial real deflation, the Chinese stock market, and with it the entire emerging markets segment, is therefore fragile. Disinflation as a result of a noticeable economic downturn could also become an issue in the industrialized countries later in the year. Investors should take this possibility into account in their scenario analyses.

Technology stocks increasingly overvalued

Taking into account the rise in interest rates, valuations on the global stock markets have increasingly reached critical levels. This is particularly true of the U.S. stock markets, and there especially of the shares of technology companies. The risk premium, i.e. the corporate earnings yield minus the (virtually) risk-free interest rate for government bonds, is at its lowest level this millennium. In relation to the high short-term interest rates, the U.S. equity risk premium is even negative. This means that investors are not being adequately rewarded for taking equity market risk. So they would be better off holding short-term government bonds. This phenomenon was last observed during the dotcom bubble, which burst brilliantly in the early 2000s. Since technology stocks account for a significant share of global markets, corrections in this segment are likely to weigh on stock markets in general. Nevertheless, there are many market segments with unremarkable valuations. If sentiment in the technology sector tips, professional investors still have the opportunity to move into peripheral, attractively valued market segments such as small caps or utilities.