Jean-Charles Mériaux, chief investment officer at DNCA Investments, is positive on credit. Photo: DNCA Investments

Jean-Charles Mériaux, chief investment officer at DNCA Investments, is positive on credit. Photo: DNCA Investments

According to Jean-Charles Mériaux, chief investment officer at DNCA Investments, the scenario for 2023 is one of stagflation, in which bonds regain interest while equities fall into line.

2023 starts on a good note, according to Mériaux: the probability of a recession, which was still high a few months ago, is decreasing significantly. “There will be an economic slowdown, that’s a given, but we should escape recession,” he said, with the exception of the UK. “Even Germany--which was a very scary [prospect]--should return to growth after a negative fourth quarter in 2022.” However, growth will be slowed down permanently by central banks and the energy crisis, he believes.

All the elements that were expected to lead to a recession--falling financial markets, rising interest rates and falling property markets--were there. Except for one: the deterioration of the labour market. “This ability of economies to create jobs in an economic downturn allows for a massive injection of purchasing power, and this massive purchasing power allows consumption to remain at good levels.”

But it is precisely this strong employment performance that means that central banks will be extremely cautious about cutting interest rates. “One of the monetary policy mistakes made in the 1970s was to cut rates too quickly during a period of inflation that was not completely under control,” says Mériaux. For him, we risk having a period of rate increases that could be a little longer than the markets anticipate.

Relative disinflation

As for inflation, he believes that disinflation is well underway in the US. “If US inflation is on a 6% trend for the year, in the last quarter it is around zero.” In Europe, the trend seems less obvious. Firstly because “the gradual abandonment of energy subsidy policies will lead to a rise in overall inflation.” And above all because underlying inflationary pressures “remain strong”.

Despite this, the markets--the same ones that were anticipating the recession--are expecting a rapid easing of monetary conditions. And this “despite the statements of the central banks,” he said. “This is particularly striking in the US.”

“The best term to describe the coming period is really stagflation,” says Mériaux.

How will the asset classes evolve in this environment? “In 2022, it was very, very difficult to protect assets because we had this double phenomenon of falling equity markets and falling bond markets.”

We finally have attractive conditions to buy bonds.
Jean-Charles Mériaux

Jean-Charles Mériauxchief investment officerDNCA Investments

In 2023, bonds will become attractive again, both in terms of yield and portfolio diversification.

“We’ve been waiting for this for years and we finally have attractive conditions to buy bonds at very satisfactory rates. At DCNA, we like credit and particularly Investment Grade credit, which we favour over High Yield. Our policy over the last few months has been to reconstitute a predominantly Investment Grade portfolio through arbitrage of High Yield positions. We have gone from 50% each to 55%-45%. We’re going to focus on Investment Grade, but to get a return, we’re going to concentrate on 3B categories. On the other hand, when we do High Yield, it will be in the best categories, the 2 B+ and 2 B.”

On the other hand, Mériaux is dubious about sovereign bonds. Especially in Europe, where the end of the ECB’s quantitative easing will force the market to absorb €600bn in net sovereign issues, “a figure that has never been reached since the creation of the euro zone. There will have to be a fairly high level of international capital participation in the placement of these bonds in order to have a good orientation of long-term rates.”

Government bonds do, however, have a place in DCNA’s portfolios, especially index-linked bonds. It makes up 10% of the portfolio, mainly Italian and Spanish debt. “Of course, it’s riskier than the Bund or US Treasury bonds, but these index-linked bonds are in the current period a very good way to protect one’s wealth without having to make a bet on future inflation.”

The earnings outlook for the year 2023 is crumbling.
Jean-Charles Mériaux

Jean-Charles Mériauxchief investment officerDNCA Investments

In equities, Mériaux sees a decline in the earnings outlook.

While stock market results were poor in 2022, the year was very good in terms of earnings, especially in Europe. This can be explained by the fact that companies took advantage of the supply difficulties to recover pricing power and protect their margins in a context of rising input costs. This phenomenon is coming to an end and we are entering a period of downward revision of results. “The earnings outlook for the year 2023 is crumbling.”

Are equity markets less attractive?

“I think we have to be aware that we have just finished 40 years of increasingly liberal policies. And we can see that the relationship between wages and capital is likely to change. The added value could shift a little more in favour of labour. We have seen that margins are under pressure. Financial results are under pressure. Companies will roll over their debts and replace loans at 0.1% or 0.22% with debt that will cost them 3, 4, or 5%. So the lenders will take a bigger share of the result. Finally, with the agreement on international taxation, it will be increasingly difficult to tax-free the results. And the increase in state interventionism seems to me to mean that tax rates have certainly bottomed out and are likely to rise again.”

“With this foreseeable deterioration in earnings, we have risk premiums that today are below their historical average,” he continues. This, in his view, makes equity markets a little less attractive.

This story was first published in French on . It has been translated and edited for Delano.