Markets Update February 2023 - Interest rate worries dampen stock market euphoria

After a strong start to the year, the stock markets recently lost considerable momentum. In the first few weeks of the investment year, everything initially pointed to a real sweet spot: improved economic prospects in China and Europe, slowing inflation momentum and thus the prospect of an imminent end to monetary tightening in the USA triggered double-digit price gains at times. Some investment strategists were already talking about the end of the bear market. But this announcement came too soon. As has so often been the case in the history of the financial markets, this time, too, it is becoming clear that fighting very high inflation rates is a marathon, not a sprint. In fact, as the major central banks are forced to raise key rates further, the risk of a recession later in the year is increasing. This is because it takes some time for monetary policy to take full effect. However, once the interest rate hikes have reached the real economy, this will inevitably put the brakes on economic activity.

Correction risks increase

Nevertheless, there is a slight glimmer of hope: corporate profits are more stable than expected and are likely to be lifted further in part by general inflationary pressures. However, the exaggerated valuations on the markets remain problematic. The very high level of interest rates on short-dated bonds suggests that key interest rates will rise noticeably in the medium term. This constellation is not compatible with the current stock market valuations, which in some cases are reminiscent of the times of the dotcom bubble. Further corrections could therefore follow.

Professional investors should therefore clearly underweight valuation-sensitive stocks in the current investment environment. At the same time, agile risk management is required in order to be able to respond adequately to the latent correction risks.