In this month’s strategy piece Alastair George believes that 2022 to date has been a tough year for investors, yet the painful post COVID-19 ‘normalisation’ trade may be nearing its climax. Long and short-term interest rates are now where they need to be to lower demand, leaving in prospect a period of disinflation as supply chain constraints ease. Furthermore, global equity valuations have fallen back to levels in line with long-term averages from bubble-like levels a year ago. Economic activity is expected to slow during H123 in developed markets, but this will not come as a surprise to investors. This development will in our view be more of a ‘Main Street’ rather than ‘Wall Street’ issue. Investors are likely to be more focused on the peak in policy rates, which we expect during Q1 in the US and shortly thereafter in Europe. By mid-2023, we expect the market mood to pivot towards an economic and earnings recovery in 2024. Triggers for improving market sentiment include further evidence of a peak in inflationary pressure as energy prices and supply chain pressures continue to moderate. We anticipate a reduction in the intensity of hostilities in Ukraine as Russia’s military objectives become increasingly unachievable. Over the course of 2022, an increasingly pressing need to boost its economy may encourage China to ease some of its less business-friendly policies, including zero-COVID. In a disinflationary environment, we would expect less valuation pressure on equities. In 2022 equities underperformed even as the global economy continued to expand because equity discount rates rose from abnormally low levels. From current valuations, we expect 2023 will be a better year for global equities and would caution against overly pessimistic positioning. With an easing in the pace of US rate increases in prospect, upward pressure on the dollar is also likely to moderate, benefiting non-US equities. It may be too early to turn aggressively positive on equities as earnings forecasts continue to fall. However, we remain neutral on equities with a positive bias as the valuation picture improves. Given elevated inflation uncertainty, we still believe investors should remain focused on building portfolios robust to a variety of economic outcomes. Current valuations for defensive stocks with pricing power, strong balance sheets and limited exposure to either war-related risks or consumer cost of living factors, suggest these remain the most attractive segments of the equity market, in our view.
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