Investment Outlook - Market Update
The year has so far been a perfect storm of hawkish central banks, higher-than-expected-inflation, the war in Ukraine and a corresponding surge in commodity prices. Also, the reality of materially higher food and energy prices. Global equity markets remained relatively resilient through the first quarter, but during the second quarter finally succumbed reacting to the constant negative headlines and increasing fears of a global recession and its likely impact on asset prices.
In late 2021 we first highlighted that we expected a material change in the outlook for monetary policy worldwide ,a ‘regime shift’ away from what investors had experienced for the previous decade. The various events to-date in 2022 have only served to accelerate this shift and most especially, the role of the central banker has moved from being the investor’s friend to that of the enemy and of spoiling the market party. We have moved as expected from an environment of market returns consisting of liquidity driven easy money alone to one where traditional fundamentals now matter with good stock picking and dividends once again an important part of total equity return. The post global financial crisis bull market is truly dead!
Looking ahead, the market consensus today expects continued rate rises by global central banks and a material slowdown in economic growth. Also, company earnings to this point have remained resilient, but must expect material downgrades for the remainder of 2022 and especially 2023! There is also a current belief (dangerously so I believe!) that inflation has peaked!. As I write, many equity markets are already down significantly anticipating much of this expected activity. The debate, of which rainforests are being currently written focuses on the nature and duration of the slowdown. Fighting deflation has made way to heated debates and a return to vocabulary not used in a long time such as inflation/stagflation, and new terms such as “slowflation” or whether it’s a hard or soft landing!! Against this background. equity markets will I believe continue to struggle and volatility remains a reality as long as these headwinds persist. Market sentiment has of late been ‘flip-flopping’ from a dominant fear of inflation one week to that of economic growth the next. Market sentiment is likely to remain hostage to headlines and we need to be patient in the meantime.
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, the virus still exists and is dominant in certain parts of the world that remain either partially or fully closed. On a positive note, a reopening albeit gradual of large economies such as China is helpful.
Asset class outlook:
At an aggregate valuation level, equity market valuations are currently more fairly valued but not yet cheap compared to historic averages. The ‘regime shift’ has had its consequences not just in delivering negative equity market returns but also notably within market indices themselves. I note for example the significant underperformance of the Nasdaq compared to the more traditional Dow Jones Industrials index of stocks .We have seen a major shift from the growth style to value and value further exaggerated by the strength of the traditional energy sector. Despite a material underperformance YTD, growth stocks and sectors remain expensive in our view with better risk-reward opportunities elsewhere in the market
Against a background of excessively overvalued and pressured bond markets and not particularly cheap equity markets, we expect the challenging background for equities to continue. We believe that the rotation towards stocks backed by strong fundamentals such as cyclical and value stocks is likely to continue through the year. We will as a team continue to focus on bottom-up stock picking and with balanced portfolios focusing on for example value, quality and dividends.
Bonds as an asset class have to-date experienced an annus-horribulus as the realities of higher inflation, higher interest rates and significantly less supportive Central Banks have impacted. We don’t believe this is yet over. Despite a challenging last few quarters, bonds remain extremely overvalued and in reality, still not far off decade low yield levels. Upward pressure will likely be maintained on yields predominantly because of continued global inflationary forces and hawkish Central Bank actions and commentary.
The upward pressure on bond yields has much further to go we believe.