Will the financial markets calm down again soon?

Zurich – The stock markets have now put the March correction behind them and have reached new highs for the year. Is this a bear market rally, or are the stock markets in the early stages of a bull market? Silvano Grimaldi, CEO of the Swiss independent asset management company Grimaldi & Partners AG, gives you the answers to these questions.

Investor optimism returns

In recent months, investors have repeatedly been surprised by sharp rises and falls in stock and bond prices. Disappointing news, such as only slowly falling core inflation rates, banks that got into trouble, etc., was often quickly followed by news that the financial markets perceived as positive, such as the first signs that the key interest rate hikes would end soon, leading indicators signaling a recovery in the global economy, etc In view of the constantly changing news situation, investor sentiment seems to be mostly good, especially on the stock markets.

But is this investor optimism really justified? In particular, will the currently generally good mood on the stock markets continue? Is it possibly already too late to invest more in equities?

Intermediate corrections could be accentuated

Volatility in equity and bond markets is likely to remain elevated for some time. As long as growth, interest rate and inflation trends do not meet the expectations of the central banks and, above all, the majority of investors, the financial markets will remain susceptible to price corrections in one direction or the other. Investment funds could, for example, amplify unexpected price declines if they are forced to sell securities due to liquidity problems. From a fundamental point of view, valuations that are exaggerated, persistently difficult financing conditions and low market liquidity could also contribute to accentuating incipient price corrections.

Stock market recovery so far driven by individual sectors and stocks

For a well-founded assessment of the current price developments, it is important to note that the recovery of most share indices since the beginning of the year is due to the quite different developments of the stocks contained in the indices. In the USA, for example, the increase is mainly due to technology stocks. Essentially, the increases in the various indices can only be attributed to these growth stocks. Without these stocks, the S&P 500, for example, would only be at the level reached at the beginning of the year. The European indices, such as the Euro Stoxx 50 or the DAX price index, are mainly based on the development of individual titles (blue chip shares), which are heavily weighted in the indices and are currently in high demand.

Opposing forces drive inflation up and down

The decline in inflation rates observed recently for import goods, producer and consumer prices also gives hope for an end to the interest rate hikes. However, globalization will no longer ensure lower costs and prices in the future. In addition, the demographic developments in many economies will be reflected in scarcity-related higher labor costs and, as a result, in higher prices for imported goods, producers and ultimately also in consumer prices. The reorganization of economic structures that is becoming necessary for the desired deglobalization and at the same time the desired substitution of fossil fuels with electricity will result in a high investment requirementand, due to a trend towards decreasing excess savings in quite a few economies, also lead to rising capital costs and higher price levels. It is still unclear how the central banks will react to the further increases in inflation that are to be expected as a result. However, increases in key interest rates to curb the rise in inflation caused by the above-mentioned factors would primarily only impair economic growth and sooner or later also have an impact on the stock markets.

On the other hand, today's production processes are much more flexible and efficient than a decade ago. Despite massive increases in key interest rates in recent months, the likes of which have not been seen since the 1980s, there has been no severe recession to this day, unlike then. Technological progress also brings an improvement in productivity. The digitization of the economy increases price transparency and thus competition between producers. Finally, the potential for increasing efficiency is enormous as AI (artificial intelligence) advances in production and consumption processes. These factors are deflationary, driving down inflation and thus having a positive impact on equity markets.

Conclusion: In pessimism every bull market has started unexpectedly

The stock markets have now recovered more than 20% since the annual low of 2022. This corresponds to the textbook definition of a bull market. Although the recovery has not yet been supported by all sectors, this is normal at the beginning of a bull market: when the stock markets turned up in March 2009, during the great financial crisis, some sectors - such as bank stocks - lagged behind. Other sectors did not pick up again until months later. This has to do with pessimism, the so-called "wall of worries". Some investors needed more time to regain confidence in equity investments. And that's how it is today, partly because of fears of recession.

Recently, the breadth of the market has increased: there are more and more individual stocks that are recovering strongly in line with the general stock market trend. In addition, the volatility indices are at a low level, which indicates that investors are becoming more calm. This makes us confident for the coming months. The stock markets should encourage the last pessimists with new highs for the year in the course of the year. Depending on the strategy, investors should therefore position themselves with a mix of high-dividend and high-growth blue-chip stocks and use interim corrections for acquisitions.

Silvano Grimaldi is a Swiss proven asset manager and founder of Grimaldi & Partners AG. He has more than 25 years of experience in the financial industry and is a sought-after portfolio management expert. During his career, Silvano Grimaldi has held numerous management positions in various banks and financial institutions and has an in-depth knowledge of asset management, capital markets and risk management.