2022 has so far felt like a perfect storm for the global economy and financial markets. Changing monetary policy, decades-high inflation, the war in Ukraine and supply-chain disruptions, to name a few, have taken a toll on investor sentiment.
The combination of high inflation and slowing growth is a clear concern, with central bank rate increases in June signalling that we are moving into a new world order in markets. Both equities and bonds have corrected in the first half of 2022, which means that even well-diversified portfolios have taken a hit. But investors should not lose faith. In fact, they would be ill-advised to exit markets now.
In our Investment Outlook 2022 titled "The Great Transition", we forecast a deceleration of growth, higher inflation than before the pandemic, central bank rate hikes, more moderate financial market performance and generally a return of economic boom-and-bust cycles.
Our projections remain valid, but the events that we have seen since then, such as the war in Ukraine or the latest Covid-19 outbreak in China, have accelerated these developments. Growth is decelerating faster than anticipated; inflation is stickier; monetary policy is normalised faster, and financial market returns so far have been outright poor.
In the near term, it has become very clear that central banks are now strongly committed to bringing inflation rates down and are willing to risk an economic slowdown to achieve this goal.
LOW STAGFLATION RISK
We have reduced our 2022 global GDP growth forecast to 3.5% -- from 4.0% at the start of the year -- but we still believe that a scenario of stagflation akin to the 1970s will be avoided. The accelerated policy tightening currently under way will help avoid the same mistakes and prevent inflation becoming an even bigger problem than it currently is.
Nevertheless, the currently still-low interest rate level is set to give way to a new, higher level globally. During this adjustment, financial markets will remain volatile. The accelerated hiking path should, however, keep the transition phase short.
Investors should take market turbulence in their stride, and it would be a mistake to leave markets at this stage. Once we arrive at the peak in the repricing of expectations, which might not be too far away, it is likely that we will see a rebound in both equities and bonds. For now, investors should continue to diversify their portfolios.
"We continue to see the risk of a US and global recession over the next 12 months as low, and expect some relief from a bounce in industrial production momentum," said John Woods, chief investment officer for Asia-Pacific at Credit Suisse.
"Strong corporate finances and sound household balance sheets remain key supports for the US and European economies. A key component of our equities-overweight has been -- and continues to be -- China, where the latest moves by the government improve the prospects of a large fiscal support for the economy."
The outlook for the main asset classes is as follows:
Equities: We maintain an attractive return outlook over the next 3–6 months as depressed investor sentiment and positioning suggest upside potential in the near term. We expect earnings to normalise yet remain supportive, thus underpinning the outlook.
Fixed income: We have recently begun recognising the incremental attractiveness of fixed income relative to equities. This is in light of the accelerated policy tightening, which would likely raise long-term yields to our target faster than expected.
We recently turned from being underweight to neutral on government bonds. We favour higher-grade bonds like government bonds and investment-grade credits as we expect the credit cycle to penalise lower-rated credit.
We continue to prefer a selective exposure to Asia fixed income. We maintain our preference for Asia high-yield ex-China property, and China sovereign bonds. Both these sub-classes offer stable fundamentals and an attractive yield premiums over their developed market peers, and have demonstrated resilience against recent market volatility.
Commodities: Physical market supplies remain tight and disruption risks elevated. On balance, we still see some near-term upside risks, but peak tightness might be near. Diversified exposure continues to serve as a hedge against inflation and negative geopolitical surprises.
Precious metals: Precious metals -- including gold -- remain vulnerable to central bank policy tightening (amid front-loading of hikes), but the scope for relative underperformance seems reduced amid growing economic concerns. Geopolitical risks still loom in the background.
Alternative investments such as private equity and hedge funds have held up much better than stocks and bonds. Including these asset classes in a portfolio where appropriate can help to mitigate overall risk and improve returns potential. Overall, moderate valuations, healthy investment activity and investor appetite support this outlook.
