2022 has turned out to be an extremely challenging year for markets, as bond and equity markets are whipsawed by uncertainty over the prospect of persistent inflation and markedly slower economic growth. We asked strategists for their best calls for the rest of 2022.
Evelyn Yeo, Head of Asia Investments, Pictet Wealth Management Asia
At this point, central banks and governments indeed face many difficult questions, and have no easy answer.
Should the Fed act aggressively (as it says it will) to rein in inflation or try to cushion demand in a US economy that looks increasingly late cycle? Should Europe continue to tighten sanctions against Russia and risk stoking the forces of stagflation even more? Should the Chinese prolong their "zero-Covid" strategy and regulatory crackdowns, and risk missing GDP target? The difficult decisions faced by policymakers mean markets are at a crux.
US markets, however, staged a noticeable comeback in the second half of March, apparently unfazed by the signal from the big run-up in bond yields that Fed's rate rises could bring economic growth to a standstill (or worse). We actually see some signs that the US could skirt recession as the finances of consumers and corporates are sufficiently robust to withstand recent price increases, and they could even increase spending. But consumer confidence has declined and corporate margins are under pressure.
For now, we remain neutral on global equities overall but are prepared for new bouts of volatility and downward revisions to earnings. We are overweight the Japanese and Swiss equity markets - the former because it is cheap, and the latter because it is full of the defensive growth companies we like. With margins under pressure, we continue to like the stocks of companies with adequate pricing power.
GET BT IN YOUR INBOX DAILY
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Earnings forecasts for major equity indexes have proven resilient so far, as the rise in commodity-connected sectors' prospects compensates for downgrades elsewhere, including in consumer-facing sectors. Valuations have been declining, especially in Europe. US equities now command an even larger premium than before. High commodity prices are beginning to dent margins, particularly in cyclical sectors.
While sanctions on Russia are having an impact on the production capacity of the car industry and other manufacturers, the current situation is also producing winners in the commodities and defence sectors. We also like the global pharmaceutical sector given the price insensitivity of its products, while European capital-goods companies stand to benefit from accelerated investment plans for energy infrastructure and efficiency. With some exceptions, European banks' direct exposure to Russia looks limited.
We have moved from underweight to neutral on US investment-grade credit (given relatively solid coverage ratios and good yields), but have moved to underweight US high yield as funding costs increase. In general, we see opportunities in credit spreads.
We see good opportunities in the currencies of stable commodity-rich economies with hawkish central banks - in the first instance, this means the Norwegian krone and Canadian dollar.
Within Asia ex-Japan, we remain cautious on Chinese equities, despite recent promises of more stimulus, as household spending remains sluggish and the property sector still faces important issues. But we like Chinese sovereign bonds, which continue to offer positive real yields, and see potential in Asian investment grade credits. Asian currencies remain vulnerable to geopolitics, and we see scope for moderate devaluation of the Chinese renminbi in the months ahead.
Steve Brice, Chief Investment Officer, Standard Chartered Bank's Wealth Management division
The post-pandemic policy easing was unprecedented, with the resultant strong economic recovery rapidly reducing output gaps. This, together with supply-side inflation pressures, is clearly putting pressure on central banks to tighten monetary policies in the coming months. This means that the expansion phase of the economic cycle could be significantly shorter than the typical 5 to 10 years. The key question for investors is whether or not this tightening will push the global economy back into recession soon.
We believe a recession is unlikely on a 6- to 12-month time horizon. Consensus 2022 economic growth forecasts are still above 3 per cent for the US and Europe. While these are likely to be revised lower in the coming weeks, it is a long way from recessionary territory.
Meanwhile, the checklist of indicators we use to assess the risk of recession is generally pointing towards continued growth. Two areas have flashed amber in the past month.
First, consumer confidence has fallen, although it is interesting to note that the majority of this decline has been due to increased concern about the outlook, which is generally more volatile, while the assessment of current circumstances remains quite strong.
Second, a much-watched segment of the US government bond yield curve briefly inverted - ie the 10-year Treasury yield fell below its 2-year equivalent. This may be worrying to some as it implies that interest rates will peak at some point in the not-too-distant future, which usually occurs when a recession is induced. However, the curve has since "un-inverted" and the more reliable part of the curve - the 3-month versus the 10-year yield - is still very steep.
Against this backdrop, we are still overweight global equities. It is normal for equities to recover sharply from geopolitical sell-offs and to rally for many months after the yield curve inverts.
Within this, we believe Asia ex-Japan equities should ultimately outperform. There is clearly relative value in the region, with the sell-off having been much more prolonged and severe. Therefore, we are just waiting for a catalyst to trigger outperformance. We believe more stimulus in China and the easing of the Covid restrictions across the region could prove to be this catalyst, especially if combined with a peaking of the US dollar.
In bonds, we generally prefer the higher-yielding areas of the market such as Asia USD bonds, which have also seen a significant sell-off, and emerging market (EM) USD government bonds where yield premiums versus US Treasuries have widened. We also have a preference for floating rate debt which will benefit from widely anticipated interest rate hikes. A specific area of focus within this is private credit which commands higher yields and a better risk-return profile overall.
Finally, we have an overweight to gold as a hedge to our overweight risk assets. This is the one area of the allocation that has performed well so far this year, although the gains have been far from unidirectional. Another inflation hedge to consider is private real estate which has had a strong performance in recent times and should offer investors a long-term inflation hedge.
Jean Chia, Chief Investment Officer & Head, Portfolio Management & Research Office, Bank of Singapore
Throughout 2022, financial markets have scaled the walls of worry - from heightened inflationary pressures and supply shocks sparked by the Russia-Ukraine war, central bank hawkishness and slower global growth made worse by China's economic woes, hemmed in by stringent Covid-19 containment measures.
Inflation has been described as a "thief", threatening companies' profitability and eroding real wages and consumers' buying power. Hence, central banks are exercising their mandate to maintain price stability through interest rate hikes and other contractionary monetary policy tools.
Concerns that monetary policy hawkishness could raise the spectre of stagflation - or the confluence of inflation and recession - have caused the recent sell-off in risky assets. Markets have been whipsawed by powerful moves in almost all asset classes - from the downward moves in equities, upward pressure on bond yields and widening credit spreads, to spikes in commodity prices and volatility in currencies.
At Bank of Singapore, we forecast a slower but still-solid global gross domestic product (GDP) growth of 3.3 per cent in 2022 and 2.9 per cent in 2023, on the premise that the growth headwinds from tighter monetary policy will be offset by economic re-opening, pent-up demand and tight labour markets.
Recessionary risks next year will be averted if inflation peaks this year and monetary tightening moderates. We expect US growth of 2.6 per cent and 1.5 per cent in 2022 and 2023, respectively, and China's growth to moderate to 4.8 per cent this year and 5 per cent next year, as full economic re-opening remains elusive despite policy support.
The propensity for 2022 to throw up wild cards across geopolitics, monetary policy, supply chain and pandemic-linked outcomes has prompted us to calibrate our investment approach based on our analyses of bull, base and bear case scenarios across financial assets.
In our current base-case scenario of higher rates, accompanied by moderate growth and heightened interest rate volatility, BOS' asset allocation strategy points towards a reduced-risk exposure to reflect caution, while maintaining sufficient cash to capitalise on opportunities thrown up by volatility.
In equities, we remain invested with neutral positions in US, Japan and Asia ex-Japan equities and stay underweight in European equities. In fixed income, we are neutral high yield - both developed markets (DM) and EM, and underweight both DM and EM investment-grade bonds.
While portfolio building points towards a long-term destination of capital preservation and growth, we cannot neglect the extreme near-term conditions that can derail our journey. Over the past months, wealth management portfolios represented by a well-calibrated range of asset classes, including alternatives such as private markets and real estate, have shown greater resilience in the midst of market volatility.
To prioritise construction of diversified portfolios, which are resilient amidst inflationary forces and short-term volatility, we advocate active management of portfolios without losing sight of longer-term objectives of generating risk-adjusted returns from a wider range of investments.
Hou Wey Fook, Chief Investment Officer, DBS Bank
As we stand at the precipice of a new inflationary era, we note that inflation has been a double-edged sword for company earnings and equity markets. Although rising inflation can boost revenues through higher selling prices, this could lead to profit margin contraction if companies are unable to pass on these rising costs to their consumers. As such, likely outperformers in periods of surging prices can be found in sectors that possess pricing power or have the ability to pass on costs to consumers, particularly sectors that provide essentials and have relatively inelastic demand.
Amid structurally higher inflation, investors should prioritise three key objectives for their portfolios: (1) gain exposure to sectors that have historically performed well in a high-inflation environment; (2) maintain sufficient exposure to growth equities to capture opportunities should bond yields peak and retrace from there; and (3) maintain a balanced allocation to high-quality credit for income generation and principal safety.
On point one, we recommend investors gain exposure to inflationary assets such as property and commodities. Among commodities, oil, metals, and gold should outperform as there are supply shortages and strong demand given the energy-transition narratives behind them.
For equities, companies which can ride on rising commodity prices, have strong pricing power, and benefit from rising interest rates will be attractive in this environment. These include the oil majors, metal mining, and property stocks. Companies in the luxury goods segment and niche consumer categories such as cosmetics, nutrition, and healthcare products should be able to pass on higher input cost to consumers. Real estate investment trusts (REITs) are property proxies which will benefit from rising property values and rentals. In addition, banks should do well in a rising-rates environment as lending rates rise.
A repeat of the 1970s stagflation is not our base case scenario, given that the high inflation which we see currently is accompanied by steady growth momentum. Nonetheless, to add portfolio resilience, we advocate that investors gain exposure to gold as a hedge. Gold has historically been a safe-haven asset and during the stagflation periods of the 1970s, gold outperformed US equities.
On the second point, we believe that the surge in bond yields is not far from a tail end, and this explains why the US Treasuries 10-year yield is currently broadly in line with consensus forecasts. Given the acute sell-down in growth equities (particularly technology), we believe that a strategic exposure to this sector encapsulates attractive risk-reward.
And lastly for point three, the rate hiking cycle has resulted in the level of bond yields as well as credit spreads now looking more reasonable. With the growth outlook priced to perfection, bonds provide a good hedge to adverse outcomes and could perform well should growth and inflation moderate unexpectedly.
Keyword added to your list