It is increasingly fashionable to talk in terms of economic and investment “narratives” – stories used to focus market discussion, for example, around the speed and extent of Fed policy tightening and the likely impact on growth. Such narratives help markets build an (albeit imperfect) consensus on future expectations, blending complex trends into an apparently coherent pattern.
The increased focus on narratives in recent years is easy to understand. Markets have had to rationalise, understand and explain a range of extreme developments around the global financial crisis, the subsequent monetary policy response, Covid and geopolitics. But narratives have their limits, particularly if market consensus is breaking down.
In recent months, for example, market narratives about the likely extent and speed of Fed tightening, and its impact on the U.S. economy, have gone back and forth. In April-June, tightening fears led to significant market losses; hopes of smaller rate rises and less economic damage then helped lift markets in June and July before tough Fed talk pulled them back down again. Markets remain, even more than usual, split between bulls and sceptics.
The underlying issue is that markets are still seeking an accepted diagnosis about the health
of the global economy. Complex factors are at play here that do not reduce easily into a simple narrative. Multiple questions remain about the U.S. consumer, European energy dependency, the success of Chinese economic reopening and possible future inflation paths, amongst many other issues: the global economy, like markets, remains under pressure.
Economic uncertainties will keep markets volatile in the short term and we think that both the
U.S. and Europe face a period of economic contraction. But if markets start to believe that these recessions are likely to be mild, short-lived and well behind us by mid-2023 (as we expect), then potential further market falls in coming months will eventually be followed by market gains. As usual, markets are likely to anticipate economic reality and, with recovery on the horizon, we forecast low single-digit index earnings growth in most developed equity markets over the next 12 months and lower but still positive returns for emerging market equities.
Inflation narratives may also take time to stabilise. A decline in bond volatility will likely depend on market confidence that inflation in the U.S. and other countries really is falling back (more than provided by limited data so far), solidifying expectations around the future Fed policy path. Market consensus will need to move beyond future headline rates to agreement on likely potential second and third-round inflation effects. And, even if U.S. inflation falls back further, markets need to accept that this is unlikely to prompt the Fed to take a much softer approach: Fed Chair Powell and other FOMC members have been signalling that we face restrictive monetary policy “for some time”. We concur with this view. The ECB, facing obstinately high Eurozone inflation, could also tighten policy further.
I would suggest that there are two main lessons we can take from these shifting narratives.
The first is that, in the real world, few developments fit a simple narrative with a straightforward trajectory and an immediately clear resolution – as some market argumentation would suggest. To state the obvious, we are traversing a demanding and continuously evolving investment landscape, but the direction of travel will become clearer and markets will respond positively. We reiterate the importance of active management and thematic investment on this journey.
The second lesson is that over-focusing on short-term market narratives is risky – as is simply standing back from the markets and waiting for new narratives to appear. One concern is that if you follow either of these approaches, then you could miss much more significant underlying long-term investment trends – most importantly around ESG issues. Ultimately, these will be central to defining future investment approaches and expectations.
Christian Nolting
Global CIO
