6 MAY, 2022
Developments in the US, Asia and Europe could lead to lower commodity prices and lower inflation, and with US investment and high yield bond yields above 4% and 7% respectively, there is good value to be had while we wait,”. Also, following the Fed’s rate hike, they note that “the rejection of the need for a 75 basis point hike may have reassured investors for now”, although confidence is “fragile”. In this context, they remain cautious and believe that “a diversified portfolio is crucial”. The experts of the team offer their view on the current market situation.
The European equity market is proving tricky to navigate for investors at the moment, with concerns centred on soaring inflation and the impact of the energy price shock. But from a market perspective, the primary fear is that of the unknown. Fundamentals were ok for Europe in Q1, but this was largely expected. Since then, the rising cost of raw materials and energy has exacerbated the deteriorating macro backdrop, leading many investors to move into defensive sectors such as telecoms and the commodity space. The fear around an economic slowdown in H2 2022 is also driving more allocation around capital preservation rather than the usual shifting between value and growth.
The combination of high inflation and a weakening global economic outlook has fuelled concerns about how far central banks will be able to raise interest rates without overburdening the economy. The outlook was already uncertain, with rising labour costs, supply-chain disruption and commodity prices that have leapt since Russia’s invasion of Ukraine all forming headwinds, but the key question is where to from here? The Federal Reserve now seems determined to tighten until inflation notably slows. Meanwhile large industrial areas of China remain shut as zero covid policy is favoured at the expense of a slowing economy, and there are some signs of the conflict in Ukraine may be headed for a ceasefire. These evolving stories in the US, Asia and Europe could plausibly lead to lower commodity prices and lower inflation break-evens and with yields in US Investment Grade and US High Yield now surpassing 4% and 7% respectively, there is good value to be had whilst we sit and wait.
Macro-economic concerns remain prominent in the market with stagflation at the forefront of investors’ minds. Over the past week equity markets have rewarded defensive sectors that have previously outperformed in stagflationary environments, such as energy, consumer staples, utilities and materials. However, in a bid to tame inflationary pressures, the Federal Reserve on Wednesday announced a 50bps rate hike, the most aggressive rate increase in a single meeting since May 2000. This had an immediate effect with US equities rallying around 3% as investors bet that inflation would be controlled and an economic slowdown would be avoided.
Despite this, geopolitical risks remain; the Russia-Ukraine conflict along with China’s stringent zero Covid policy has led to great pressure on European economies, with the Euro area recording a low GDP growth of 0.2% for Q1 2022. Europe has continued to ramp up sanctions on Russia, now proposing to ban all Russian oil over the next six months. In addition, key Russian banks are being targeted by the EU, with a SWIFT payment system ban being proposed. The severe lockdowns in China’s major metropolitan areas have led to further supply chain interruptions and continues to impact company operations all over the world; a theme frequently mentioned in earnings reports over the past week.
The rejection of the need for a 75bp raise may have reassured investors for now, but we have seen over the last few months that confidence is fragile in the face of geopolitical turbulence. We remain cautious and believe a diversified portfolio is crucial in these markets.