Equity markets have largely reacted positively following the FOMC meeting last week. Long-term inflation concerns have subsided with inflation expectations falling to 2.8% p.a. in July vs. 3.1% in June (University of Michigan Survey of Customers). Concerns about an impending recession has replaced worries about rising prices with growth indicators signaling a slowdown. United States Q2 GDP has contracted 0.9% on annual basis. Composite PMI numbers from major global economies also show a contraction in business
activity. Resurgence of Covid-19 cases in China can potentially serve as a headwind to growth entering the final months of 2022.
Weakening business activity data combined with the political uncertainty in Italy does not bode well for Europe with Goldman Sachs predicting that the Euro Area will see a recession in the coming months. Following Draghi’s resignation, Italian elections are scheduled for September 25 with the new
government being sworn in early November. This leaves a tight deadline for approving the national budget for 2023 and likely the implementation of the Recovery Fund in Italy will be delayed. This sets a gloomy outlook for Italy’s growth prospects and could worsen fragmentation among the political units.
Contraction in Europe can worsen in the event of disruption of gas flows from Russia or spillover from a potential US slowdown in growth. UBS believes that the risk-reward for broad equity indices will remain muted with an approach favoring value stocks, quality income and healthcare with optionality being the
best tactical approach. In the longer run, a diversified portfolio will allow investors to take advantage of lower equity valuations and high bond yields to generate strong returns.
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