As markets remain caught between concerns about rate increases and the risk of recession, Schroders warns that the current economic cycle may be approaching its end, and that the risk of stagflation has “significantly increased”. Coupled with other uncertainties, investors will need to brace themselves for continued volatility in the second half of 2022, or even beyond.
Whilst central banks around the world are acting to control inflation, Keiko Kondo, Head of Multi-Asset Investments, Asia, Schroders, said keeping a close eye on the consequences of rising rates will be critical.
Keiko Kondo said: “Right now, central banks are focused on normalising policies above all else. This is mainly due to the fact that traditional inflation models are vulnerable to supply bottlenecks caused by a myriad of unprecedented sources. These include changes in post-pandemic spending patterns, Covid lockdown measures, and an ongoing conflict between Russia and Ukraine.”
“Although we continue to believe global economic growth for the whole of 2022 is reasonably well underpinned, with liquidity tightening and growth potentially peaking, downside pressures on both equities and fixed income assets remain high. With rising interest rates, we see a bit of room to hold on to relatively more cash in a diversified portfolio and be patient in waiting for better times to deploy that cash. Our cyclical models are pointing to a shift into the ‘slowdown’ phase, which is typically the most challenging phase of the cycle for equities,” Keiko Kondo added.
The firm remains conservative on equities, particularly focusing on areas of secular growth in Asia and value-oriented global companies that are involved in semiconductor, sustainable food and water, and smart manufacturing.
“Zooming in on Asia, we are starting to turn more positive toward Chinese equities. With our concerns about rate increases dominating our views in other markets, recent data indicates the likelihood of looser monetary policy in China, and this together with attractive valuations present us with a relative opportunity versus broad markets.”
On the fixed asset front, global valuations look relatively more attractive but remain vulnerable to further increases in interest rates.
Keiko Kondo commented: “Asian credit is less susceptible to global fund flows, thanks to a larger domestic investor base in the region. Besides, the asset class has a higher quality composition compared to other emerging markets. However, we must note that rate volatility and macro risks are still in the rear-view mirror. Therefore, we would at this point prefer bonds that are of higher quality and with shorter duration.”
Owing to potential negativities over the near-term outlook, Schroders thinks that gold, broader commodities and currency can be viable means to diversify portfolios.
“Given the increasing divergence in monetary policy between the US Federal Reserve and the European Central Bank, our current view is that the US dollar can act as a portfolio diversifier that hedges some of investors’ unwanted risks,” Keiko Kondo added.
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