Financial markets are driven by sentiment – but this sentiment always reflects an underlying logic. Understanding this logic becomes particularly important at a time when uncertainty is high.
We are only halfway through 2022 and this has already been a year to remember in terms of geopolitics, macroeconomics, and monetary policy shifts. As Shakespeare so memorably observed: “when sorrows come, they come not single spies, but in battalions”. Uncertainty is still at high levels on many issues including future inflation levels, global supply disruption, economic growth, policy responses and, importantly, coronavirus.
As always, market pricing reflects a variety of assumptions about what will happen next. These assumptions may of course change in future. It is possible, for example, that markets start to expect less aggressive monetary policy tightening than they do now – which will have multiple impacts on the relative attractiveness of asset classes. It is also important to remember that market pricing also represents a composite view of multiple risks – not a simple assessment of a single problem.
What can we take from this in terms of portfolio management?
First, that high levels of uncertainty do not mean that portfolio decision making can be put on hold. It may be difficult to foresee the future, but market logic is still continuously trying to predict it – and portfolios need to acknowledge these shifting market expectations.
Second, that it is very important to look beyond the headlines. If markets are pricing in a composite assessment, it makes sense to understand the different factors contributing to it. But, as part of this more granular assessment, we need to look at both long and short-term price drivers.
We can also, I believe, be reasonably confident about certain parameters. So, while expectations around future interest rate levels will doubtless shift again, the era of ultra-low nominal interest rates now appears to be behind us – although it is certainly premature to talk about policy “normalisation”. Higher rates will encourage a reappraisal of the relative appeal of different asset classes. With “income” now back on the agenda, fixed income’s appeal as an asset class may now be increasing – despite the possibility of default rates rising from current very low levels. This, in turn, might dilute the “there is no alternative” (or TINA) case for equities – but it does not remove it. Overall equity valuations are still attractive, corporate earnings appear solid and our forecasts see 12-month gains, albeit with volatility in the interim.
At a granular level, assumptions on interest rate rises will have an impact within asset classes,
for example on the relative appeal of different equity styles and sectors – as we have seen in the performance of “growth” and “value” stocks in recent months. A continuing focus on immediate risk management will be necessary. But, going back to the second conclusion above, it remains important to stay disciplined, look beyond immediate market moves and keep a firm hold on long- term objectives, asset allocation and investment themes.
Forecasting the future is, of course, not a matter of simply extrapolating the past. The global economy could look very different in 12 months’ time. But I think that we need to work on the basis that the macroeconomic and investment environment will remain potentially very fragile. Recovery will not be simple and, even on the most optimistic assumptions (for example on Chinese economic reopening), issues such as supply chain disruption will take time to fix. I also remain very concerned about social and humanitarian stresses in many countries arising from the pandemic, inflation, or the disruption of food supplies from the Ukraine – these stresses could get worse before they get better.
But I think that the key lessons remain: do not delay portfolio decision-making, use risk management strategies appropriately, and keep a firm hold of long-term objectives. This is how to navigate through the second half of 2022, and beyond. We always look forward to guiding you.
Christian Nolting
Global CIO
