This must be taken into account in our investments

At the June meeting, the European Central Bank (ECB) announced that it will end net asset purchases as of July 1 and that it intends to increase interest rates at 25 basis points at the July meeting.

But there is more. Official interest rates are expected to rise again in September. All this will depend on the update of the medium-term inflation outlook. If the medium-term inflation outlook remains the same or deteriorates, the monetary authority warns that a higher increase will be appropriate at the September meeting.

At the same time, despite the slowdown in purchases, it is expected continue to fully reinvest the principal of the securities acquired maturing for an extended period after the date on which the ECB’s official interest rates begin to rise and, in any case, for as long as is necessary to maintain ample liquidity conditions.

The rise has not occurred, but the market discounts expectations so We can now begin to gauge what this movement means for our investment portfolio.

Looking for the appreciation of the euro

If we put ourselves in context, the US dollar strengthened As prevailing risk-aversion sentiment fueled by concerns over Russia’s war in Ukraine, rising inflation, supply chain issues and slowing growth prompted investors to turn to traditional assets.

At that point there are movements by the Federal Reserve to increase interest rates, which has led to a fall in the euro against the US currency until it aroused fears of parity between the two. The Federal Reserve raised rates by half a point to 0.75%-1% during its May 2022 meeting.

The devaluation of the euro, which today is trading at 1.04 dollars, together with the escalation of inflation, have been the precursors to the change in the ECB’s monetary policy. Well, otherwise, because most raw materials are priced in dollars, inflation would be imported if the euro were allowed to sink.

If the ECB complies with what has been said and follows in the footsteps of the FED, we should see a stabilization of the pair, or an appreciation of the euro/usd, partially reversing the lead that the US monetary authority has taken in the first part of the year. If the FED does not maintain the aggressiveness, parity will be closer.

Later It will be necessary to see if the rise in interest rates precipitates a recession. In this case, the Fed tends to take the lead in the form of lowering rates, which tends to devalue the dollar and, consequently, appreciate the euro.

Let’s evaluate the investment portfolio

We are facing a complex reality for equities. It is presumable that despite the rate hikes, for now they will be timid, so that the energy crisis will have repercussions on a growth in energy costs, which, added to the rise in labor costs, will end gobbling up the margins.

Also, valuations have not really improved given lower earnings prospects and the expected pace of rate hikes. The prospect of higher interest rates is raising the expected discount rate. A higher discount rate makes future cash flows less attractive.. Hence, the Nasdaq is falling 30% as it is the sector that is deteriorating the most in the review of expected future flows.

The financial sector draws attention with the great bank as its flag. Theoretically, a rise in interest rates should be understood as positive for banks because it improves interest margins. Nevertheless, we find banking securities whose business is beyond our borders (BBVA and Santander) are marking minimums below the minimums marked by the outbreak of the Russia-Ukraine crisis.

The reason underlying this deterioration in prices is that a drop in economic growth in global terms is being discounted. Banking is a cyclical business and if it enters into stagflation, your business will suffer.

So where should we rotate the portfolio? The first objective that the stock investor should set who wins in the current environment.

Undoubtedly, one of the sectors that must be given weight in the portfolio is energy, which includes oil and gas companies. These companies beat inflation 71% of the time, with real returns of 9%. It makes perfect sense as they are the first beneficiaries of this newspaper. In fact, so far this year Repsol adds an advance of 49.58%, leading among the Ibex 35 values.

Socimis own real estate assets and they can provide a partial shelter from inflation through the pass-through of price increases in rental contracts and property prices.

On the fixed income side, your coupon payments generally become less valuable as inflation rises, driving your yields higher and through price declines to compensate. In this point, rebalance the fixed income partlowering the duration to minimize the sensitivity of these financial instruments to rate increases.

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