September insight: Monetary policy error in prospect?

Written by

Neil Shah

We open with a strategy piece by Alastair George, who notes that incoming economic data continue to indicate slowing economic momentum in the US and Europe. Yet oil prices are rising and now in positive territory year-on-year, suggesting headline inflation may take longer to reach targeted levels. A period of stagflation is unlikely to be helpful for equity markets.

Any interruption to the recent disinflationary period increases the risk of a monetary policy error, where policy is maintained at restrictive levels for too long. A deceleration in the money supply not seen since 2008 is evident in both the US and Europe. We continue to believe that long-term US government bonds remain attractive, despite the recent sell-off. Investors should also attempt to separate the long tail of COVID effects from traditional inflationary components. Over the past several years, governments’ policy response to COVID-19 has induced supply chain disruption, a surge in demand for goods and contributed to the current tightness in labour markets. A slowing growth environment is likely to benefit more defensive segments of the equity market on a relative basis. Economically sensitive sectors are likely to come under pressure if global growth slows as survey data indicate. We also believe balance sheet strength will be rewarded by investors, as debt funding costs increase. We maintain a neutral outlook on global equities and anticipate a rotation in sector performance as economic growth slows over the coming quarters. We note that the valuations of US equities are still high despite the 8% fall since the peak during the summer, especially in the context of consensus forecasts for single-digit earnings growth for 2023. We continue to believe that long-term government bonds are attractive as recession risks may become increasingly visible.