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The UK's policy experiment ‘is going terribly bad’: Strategist

Pictet Asset Management Chief Strategist Luca Paolini joins Yahoo Finance Live to discuss the outlook for a global recession, economic uncertainty, investor sentiment, bond yields, and inflation.

Video transcript

BRAD SMITH: Keeping tabs on futures this morning, as we are lower for the Dow, the S&P 500, and the NASDAQ with just about 15 minutes until the start of trade here in the US, as investors continue to zero in on inflation. But our next guest says that a global recession is inevitable and US investors should diversify away from US stocks.

Pictet Asset Management chief strategist Luca Paolini joins us now. Luca, thanks for taking the time here with us--


BRAD SMITH: In-set. Yes, good morning indeed. OK, so you're saying that a global recession is inevitable. But even the inevitable nature of that, what is the extent? What's the depth of that you would be looking at and tracking?

LUCA PAOLINI: Well, first of all, let me say that a global recession wouldn't surprise anyone. I think it's probably also priced in. I think the question is how deep it's going to be and how bad it's going to be for markets.

And I think a lot of this will depend on the reaction of central banks. We have seen this in the UK, for example. So I think it's almost inevitable to have a recession. We have a recession basically in the US. We have one now in Europe, one in the UK, we have basically one in China.

So I think we have to get ready for that. So the question will be how deep it's going to be and how bad it's going to be reflected in earnings, which I think are still too high.

JULIE HYMAN: I want to focus on the UK for a moment, which is where you're based. Is what Prime Minister Liz Truss is doing and the Bank of England going to make the situation worse or better in the UK?

LUCA PAOLINI: Well, the problem of the UK is this-- this is a country where it's very dependent on foreign capital. So I think it's very important that the pound doesn't collapse, because otherwise investors are not coming. The second point is that there is a total contradiction between what the government is doing and what the central bank wants to do.

And this creates a lot more uncertainty. And also, there is another issue that the idea of this fiscal package could be potentially right, but the timing is awful. Because you see the central banks told us just a few weeks ago, we are going to basically do QT. And now, actually, they're doing the opposite. I think this kind of--

JULIE HYMAN: Because the government is forcing them to, effectively.

LUCA PAOLINI: Exactly. And I think it's just the fact that the IMF is telling the UK, this is the wrong policy, that's really kind of unprecedented. And there is also-- by the way, the politics is important. This government hasn't been elected. And so there is also this kind of angle they have to keep in mind-- and this increases the uncertainty that we see in the UK.

BRIAN SOZZI: If the pound does collapse, what type of ripple effects would that cause in other currencies and in US equity markets?

LUCA PAOLINI: Well, you see that even in the US-- I'm surprised that a lot of people are worried about the UK. Why? Because this is a policy experiment that is going terribly bad. So everybody is watching here. Bond vigilantes are back, so everybody is watching.

I don't think that UK or what happens in the UK will be the catalyst for a global recession, because I think it is probably going to happen anyway. But there is a sense that bond investors are looking and you have to be very careful what you're doing in terms of communications, in terms of decisions. Because we have been punished.

And you look at the volatility of gilts, went down 25%, up 25%. This is, like, the volatility that you have in Bitcoin for the bond market. So obviously, there are significant implications.

BRAD SMITH: One of the areas as well that you think is overweight is quality growth stocks right now. How would you define a quality growth stock in this environment?

LUCA PAOLINI: Well, quality basically is balance sheet-- strong balance sheet, stable margins, strong sales. This is basically what we define as quality. Growth is interesting, because growth when you think about growth, you think tech. And tech has been suffering a lot.

But we think they're very close to a peak in bond yields in the US. And if you're right, given the decline that we are seeing in tech stocks, I think there is some value there as well. So that's why I think quality stocks for us is the place to be. And also, obviously, some defensive names-- we like pharma stocks, because they're not really affected by the cost inflation, very solid earnings, and they tend to benefit from a strong dollar. So that's what we like right now.

JULIE HYMAN: And then there is the UK overweight on UK equities. And I had to ask my team to read it to me a couple of times to make sure I was hearing it correctly. So given our discussion just now about the UK situation, why overweight UK stocks?

LUCA PAOLINI: We have been reducing our weight in the UK. But the point of the UK market is that 80% of sales are basically abroad. So when the pound gets weaker, typically, a lot of companies, they benefit. So I think the UK market-- the UK is now kind of almost like a market meltdown. But UK equities are different.

They are kind of defensive. There is a lot of commodity exposure, strong brands. And they tend to benefit from a weaker pound. So I think the kind of meltdown we've seen in the pound is not really reflected in the equity price in the UK. And that's why we have been reduced our position, but we still like the UK markets.

JULIE HYMAN: Interesting. I'm curious now-- we're about to end the third quarter, of course, and we had that little attempt at a rally here in the US that then faded out. Any sort of lessons learned as you look back over the quarter that now have helped you think about your framework for the end of the year?

LUCA PAOLINI: I think the lesson I think is simple-- that inflation is always a problem. And once you have inflation like this, there are always tensions, market turmoil, credit accidents, and these kind of things. Now, I think for us, it's more not about inflation and central banks, it's about earnings.

And I think the focus should be on earnings because I think there is now that we go from a duration shock, so, let's say, higher interest rates, to a gross shock. And this is where I think we feel more worried about. And the next earnings season is going to be really critical.

BRIAN SOZZI: Indeed, it is. All right, Pictet Asset Management Chief Strategist Luca Paolini, good to see you in studio. Appreciate it.

LUCA PAOLINI: Thank you.