Investment Outlook - Market Update
2022 so far has been dogged with significant negatives such as reality of higher-than-expected inflation, significantly more hawkish Central banks and this before reflecting on the sad and tragic war in the Ukraine. Despite all this negative news, global equity markets have generally been much more resilient than might have been expected so far during 2022.
Towards the end of 2021, we highlighted a material change in our outlook with respect to expectations for interest rates, suggesting that a ‘regime change’ now lay ahead and investors should expect and plan for a period of increasing short-term interest rates and an end to quantitative easing. This has certainly become a reality and so also the definition of regime change has broadened to now also include a challenging new world order when it comes to the outlook for geo-politics, globalisation and protectionism.
Looking ahead, market consensus calls for the economy slowing through to the end of next year, but not falling into a recession. We don’t disagree with this and remain generally of the view that the global economy is far more resilient than feared and can withstand more interest rate rises than many fear it can. We are not in the camp that argues ‘inverted yield curves’ mean recession. The world economy is at present very strong, as evidenced for example by the employment markets. At the same time, CPI inflation is globally elevated, and showing no signs of subsiding. The Fed is embarking on a tightening cycle as they play catch-up. We expect similar elsewhere.
Against this background. equity markets should struggle to make much meaningful progress from here, but neither do we believe is there a serious bear market ahead. Equities are a real asset and with positive earnings and dividend growth ahead should remain more resilient than some may fear. A growing economy supports real assets. That said we continue to argue that components of global equity markets remain overvalued and certainly those growth sectors that have benefitted valuation wise from the support of low bond yields. Growth sectors have begun to struggle and should continue as such.
As investors we currently argue for calm rather than panic. We do remain ever vigilant to the many risks and challenges that surround us as already highlighted. We are also mindful that although Covid has generally ceased to be a market factor, that the virus still exists and is dominant in certain parts of the world that remain either partially or fully closed.
Asset class outlook:
At an aggregate valuation level, equity market valuations are above neutral but not excessively valued we believe. We have long argued that equity markets should see a transformation to fundamental drivers and away from liquidity driven, coincident with ‘regime change’. This ‘rotation towards normal’ has begun, albeit not yet in a straight line. While growth stocks had underperformed earlier in the quarter, we note they recovered late in the quarter with the associated evidence of the re-emergence of retail investors and the recovery in speculative meme stocks. We re-emphasise our confidence that a recession will be avoided and investors don’t need to pay high valuations for earnings scarcity especially given the rise in long bond yields.
Against a background of excessively overvalued and pressured bond markets and not cheap equity markets , we expect a strong tug-of-war for equities to continue, during 2022. We believe that the rotation towards stocks backed by strong fundamentals such as cyclical and value stocks is likely to become evident through the year. Over the coming quarter, it is likely that equity markets make little progress in either a positive or negative direction.
Bonds as an asset class have finally succumbed to the fundamental realities of higher inflation, higher interest rates and significantly less supportive Central Banks. This we believe is a journey that has just started and far from ending soon. Despite a challenging last few quarters, bonds remain extremely overvalued and in reality not far off decade low yield levels. Upward pressure will likely be maintained on yields predominantly because of continued global inflationary forces and significantly more hawkish Central Bank actions and commentary.
The upward pressure on bond yields has much further to go we believe.