21 JUL, 2022
By Constanza Ramos
After six months of navigating rising rates, inflation and geopolitical tensions, recession fears are on the rise for 2022, casting a long shadow over prospects for global economies and markets in the second half of the year.
Results of a mid-year survey of 34 market strategists, portfolio managers, research analysts and economists at Natixis Investment Managers and 15 of its affiliated investment managers, as well as Natixis Corporate and Investment Banking, show that nearly a quarter (24%) believe a recession is inevitable in the second half of 2022, while 64% believe it is a distinct possibility. Nine in ten believe central bank policy will be the biggest market driver over the next six months.
“Ten years of over-reliance on easy money led to significant outperformance for growth equities. That’s over for the foreseeable future. The biggest market driver at the end of 2022 will be central banks and bringing down inflation to lower the longer-term cost of capital,”Katy Kaminski, Chief Research Strategist and Portfolio Manager, AlphaSimplex Group LLC
Key market assumptions for low rates, low inflation, and low volatility may have boosted market performance for more than a decade, but since the start of the year that unique confluence of factors has been reset. The catalyst for much of this shift has been inflation.
In fact, seven in ten rank inflation as the biggest market risk for the second half of the year. Even though it has tapered slightly since its high, 36% of respondents go so far as to set the level of risk due to inflation as a 10 out of 10.
Central banks also factor into the picture with 52% citing their policy decisions as a key inflation driver. Another 46% also believe that the supply chain issues that helped drive inflation early in the pandemic will continue to do so through year-end. However, less than one in four believe inflation will remain persistently high.
Faced with prospects for rising interest rates and tightening monetary policy, strategists place recession as a close second on the list of concerns with 64% ranking it as a top risk.
Policy makers have many tools at their disposal to address inflation and given the challenge of achieving the right timing for policy implementation, the margin for error is slim.
For many the question remains as to whether these efforts will thwart inflation, trigger a recession that could last two to three quarters, or result in stagflation that lasts for years. With all the possible outcomes, no wonder more than half (55%) of those surveyed also cite a central bank error as a key risk.
“The word recession is casting a long shadow over the markets, but in some ways the only way out of this inflationary environment is for central banks to trigger this recession. Then we’ll come out on the other side of the inflationary shock, and the markets could then rebound,”Mabrouk Chetouane, Head of Global Market Strategy, Natixis Investment Managers Solutions.
Inflation, recession and central bank policy may factor prominently in their views on market risks. Yet strategists also see the potential for world events, like the war in Ukraine, as key risk considerations as 65% of those surveyed place geopolitics as a top risk and as an offshoot, nearly half of those surveyed (47%) see energy prices as a significant risk for markets in H2.
To underscore the connection between politics and energy, oil prices spiked to $120 per barrel in at the outset of the war in March and has since moderated to $106 at the end of Q2. Looking ahead, nearly half of strategists (49%) anticipate West Texas Intermediate crude will end the year somewhere in the range of $100-$125. And while there is still 15% who believe prices will rise past the $125 mark, the larger number (33%) forecast that prices will drop between $85 -$100.
Of all that strategists forecast for H2, the most telling sign of the times may be how their views on COVID-19 have changed. Where the pandemic had resulted in a worldwide lockdown in 2022 and continued work from home orders in 2021, even with the highly contagious BA variants spreading globally, few (9%) believe a COVID disruption will present a risk in the second half of the year.
One of the key trends to emerge out of pandemic-driven disruptions has been the outperformance of value stocks. Low rates and low volatility had provided a rising tide in which most stocks excelled over the past decade. As a result, it was harder to find underpriced stocks.
Now, with rates on the rise and volatility back in earnest, value strategies have outperformed growth. Almost six in ten (58%) believe the run will be extended for at least a few more months, while one-quarter (24%) think value will be on top for a few more years. Less than one in five (19%) think the value trend has already run its course.
“The opportunity set is shifting rapidly. The new environment is creating idiosyncratic opportunities that are more attractive investments than the broader indices. These opportunities can be found across multiple sectors,”Chris Wallis, CEO, CIO, and Senior Portfolio Manager, Vaughan Nelson Investment Management.
One of the biggest changes to the investment landscape over the first six months of 2022 has been the slow and steady increase in interest rates, with bond yields following in step. After closing out 2021 at 1.512, a series of rate hikes – including a surprise 75 basis point hike in June – put yields at 2.975 on June 30, 2022.
Underscoring just how closely they will be watching central bank policies in the second half, 73% of those surveyed believe there will be more increases: 36% believe US Treasuries will finish the year somewhere between 3% and 3.5%. The same number anticipate even more hikes and forecast rates reaching above 3.5% by year’s end.
“This year, the global bond markets suffered unprecedented losses, and few people would have ever thought of bonds as unprotected money. But there are signs that we’ve passed the high of inflationary pressures, and now is the time to find the opportunities out there, for instance in financials, energy and industrials,”Adam Abbas, Portfolio Manager and Co-Head of Fixed Income, Harris Associates.
As strategists view this new fixed-income landscape there is no clear consensus on what it means for investors. Rate hikes may continue to depress bond values according to 27%, creating attractive opportunities for those who know where and how to look. Those taking the cue from the 27% who say it’s time to start buying bonds again may want to consider the advice of the 24% who say that at times like this credit quality will matter more than duration.
Strategists see a world that has changed dramatically in the past six months. After a decade in which the easy money provided by quantitative easing, low rates, and low inflation propelled markets to positive gains in seven out of ten years, the world is moving on. This next normal is marked with greater volatility and greater uncertainty. The big question for most investors may well be how long will it last?
By Generali Investments