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Grooss Struuss, 35, L-9991 Weiswampach, Luxembourg

Capitulation alone won’t do for investors

As earnings season is still watched closely, leadership in the UK has changed yet again. Meanwhile, investors have been capitulating throughout the year. But is it enough? What do current conditions mean for you? Discover the views of our experts in this Research Weekly.

Key take-aways

  • Investors first capitulated on energy price spikes, then in equities, and now in China and in bonds. This creates room for countermoves, but not all of them are likely to last.
  • The bottoming out of risk assets is proceeding as expected. We see our more constructive stance on Europe’s handling of the energy crisis confirmed.
  • In the UK, following the resignation of Liz Truss, former Chancellor Rishi Sunak is the latest British Prime Minister.
  • A Sunak government could introduce more feasible fiscal plans that help restore confidence in the UK’s fiscal policy, stabilising the pound and eventually reducing the risk premium on gilts.

Earlier this year, investors capitulated in commodity markets and bought into the ‘commodity super cycle’. Yet six months later, commodity indices have turned in a ‘death cross’ (a technical signal indicating ‘more downside ahead’).

This is particularly noteworthy for Europe, where the political and media arenas engaged in apocalyptic storytelling all summer long. Yet despite all the doom and gloom ahead of the feared winter of 2023/2024, gas spot prices in Europe are currently well below anything seen so far during the energy crisis. Some of them are even below pre-crisis levels.

There are clearly special factors at work too. Yet it is worthwhile acknowledging that our more constructive view on Europe’s handling of the energy crisis is materialising.

What impact has this had?

After the summer, investors started capitulating in equities too. Bourses panicked over the relentless monetary tightening by leading central banks, triggering another massive selloff in September 2022. Still in capitulation mode, investors then turned to bond markets. Hence, bond yields spiked above the 4% level in the 10-year US Treasury market last week. This marks the highest level since the Great Financial Crisis.

If it were as easy as buying into anything where investors have capitulated, you could leave investing to algorithmic trading altogether.

Christian Gattiker, CFA, CAIA, Head of Research at Julius Baer

And after the weekend, the capitulation moved to China, where foreign investors pulled the plug on their long-term positions in the Middle Kingdom after recent announcements about political leadership. Yet just to be clear: capitulation alone will not do. If it were as easy as buying into anything where investors have capitulated, you could leave investing to algorithmic trading altogether. But as an investor legend put it, “Investing is simple but not easy”.

Hence, these capitulation signals must be taken one by one to assess the odds of a more sizeable countermove. For now, we view the bottoming out in risk asset prices as confirmed. This means stock markets and corporate bonds have further to go. In contrast, we see continuous downside in commodity prices. For China, we do not view the landslide in stock prices as a long-term buying opportunity.

What’s happening in the UK with GBP?

On 20 October 2022, UK Prime Minister Liz Truss resigned after only 45 days in office, the shortest tenure in history. The damage done by the ‘mini budget’, which eroded voters’ and financial markets’ trust in the UK’s fiscal policy, was simply too large. Watering down the tax cuts and replacing Chancellor Kwarteng with Jeremy Hunt, who then called off most of the plan’s measures, did not help Truss to restore the backing from her party. Given the reputational damage, the Conservatives confronted a huge loss in voter support and have fallen far behind the Labour Party.

The task for the next party leader and PM, Rishi Sunak, is huge: restoring confidence in the UK’s fiscal policy and battling high inflation while spurring growth and winning back voters.

The new government will surely be prudent about elevated sensitivity on fiscal policy and not repeat Truss’s mistakes. A Sunak government has particular potential to restore confidence, as he had already competently sailed through the coronavirus crisis as Chancellor. In his past campaign, Sunak promised to expand direct support to households to mitigate the cost-of-living crisis and to cut the VAT on energy bills but not to endeavour on more risky tax-cutting operations as Truss had attempted.

Therefore, we see the potential that Sunak could further calm markets, which would keep the pound more stable going forward. More visibility will be needed for markets to price out the risk premium on UK gilts, but the chances of gilt yields softening further are rising.

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