We open with a strategy piece by Alastair George, who believes that global markets appear to be processing incoming data one step at a time. The first step was to acknowledge that monetary policy will need to be tighter than expected as inflation has surged. This has pushed long- and short-term interest rate expectations higher. For more highly valued segments of the equity markets, there has been a substantial valuation correction during H122. During June, investors have started to discount the consequences of a sustained period of tighter monetary policy (step two). A meaningful economic slowdown is evident both in purchasing managers’ indices and a sharp decline in consumer confidence in the US and UK. Industrial commodity prices such as copper and iron ore have been under significant pressure as growth expectations for 2022 are scaled back. After the valuation reset of the past 12 months, equities are now at risk of profits downgrades (step three). Investors should be patient during this period. In our view, equities will represent a better risk/reward when earnings forecasts have bottomed. Rather than underwriting the current expansion, which appears to be nearing its peak, we believe investors will be better served by anticipating the ultimate recovery (step four), or the final step in the market cycle. Stagflation may require a different portfolio response to a typical slowdown. With war-related global supply chain challenges in food and energy, inflation may be more resistant to interest rate increases than originally expected. For the medium term, we would be cautious about over-allocating to nominal assets even as they shield short-term market volatility. We remain neutral on equities and bonds and believe the focus should be on hedging risk rather than looking for outsize gains. Following the market declines, price/book valuations for equities are no longer so obviously elevated. We believe balance sheet quality and earnings and margin resilience will be positively correlated with medium-term performance. Furthermore, with close to double-digit inflation across developed markets, investors can no longer be sure cash will protect real wealth.
We welcome any comments/suggestions our readers may have.
Download June 2022 edition of Edison Insight here
