12/09/2022
What does this mean for investments?
The main conclusion: The new regime requires more frequent adjustments to portfolios. Time horizon is also key. In the short term, we’re underweight developed market (DM) equities on a worsening macro outlook. Central banks look set to overtighten policy and stall the economic restart. The recessions we predict are not priced into equities, we think. That’s why we aren’t buying the dip. Longer term, we’re modestly overweight DM equities. They have relative appeal over private growth assets – those have yet to reprice like their public counterparts – and fixed income, where we see higher yields dragging on expected returns. Sectors that we believe will benefit most from long-term trends like the net-zero transition, such as technology, are also particularly well represented in the DM equity universe.
Publicly traded credit is an overweight in our strategic portfolios for the first time in years as yields and spreads have materially repriced. That includes high yield. Tactically, we prefer to be up in quality in investment grade since we think it could better weather a slowdown that equites haven’t priced in yet. Lastly, we’re overweight global inflation-linked bonds, now and even more so further out. Why? We think markets are once again underappreciating the persistence of higher inflation. We’ve been arguing all year we’re in a new regime of heightened macro volatility driven by production constraints. In the near term, they are caused by Covid supply disruptions and labor shortages. In the long run, we see them pressured by structural forces such as a bumpy net-zero transition and a rewiring of global supply chains amid geopolitical tensions.
12/09/2022
Market backdrop
Stocks ended lower in a volatile week after Powell’s hawkish Jackson Hole comments about the Fed’s “unconditional” objective to bring inflation back down to its 2% target. On Friday, U.S. jobs data showed another month of job gains alongside an increase in those searching for jobs. Given Powell’s tone, we see the Fed hiking through this year and think it will only stop tightening once it sees the damage to growth and jobs from higher rates.
The ECB will be the center of attention this week, and we expect it to raise rates by 0.75%. An ECB executive board member’s comments at Jackson Hole suggest the central bank is starting to acknowledge that reducing inflation to its 2% target will come at a sizable cost to jobs and growth. We’ll be assessing how much that’s reflected in the ECB’s updated forecasts. We see the ECB hiking rates through 2022 and then stopping amid an energy shock-triggered recession.
12/09/2022
The outlook for Europe
Europe is a different story; we’ve expected recession there for months given the energy crunch. By year-end, rate rises will push the euro area into a deeper recession. The European Central Bank (ECB) appears just as determined as the Fed to fight inflation by raising rates. At Jackson Hole, ECB executive board member Isabel Schnabel acknowledged a trade-off between taming inflation and maintaining growth. Yet she stressed a “robust control” approach to monetary policy, focused on getting inflation down at whatever cost. We think the ECB will hike 0.75% on Sept. 8. But like the Fed, the ECB is not grasping the full extent of the recession needed to crush inflation, in our view. We think the ECB will keep raising rates through the rest of the year but stop earlier and well short of market projections when faced with the gravity of the recession.
