Equity strategy and market outlook – May 2022

In this month’s strategy piece Alastair George believes that a global slowdown appears to be underway. Survey data show a steady deterioration in business optimism and consumer confidence in developed markets. He suggests it is too early for anyone to answer precise questions of how deep or how long the slowdown will be and portfolios should be managed accordingly. The main uncertainty is the duration of the surge in inflation and the resulting timing of the inflection point in monetary policy tightening. Energy prices and headline inflation are strongly correlated. If oil prices remain above $100 per barrel, headline consumer price index (CPI) inflation is likely to remain well above 2% in the US and Europe over the next 12 months. Consequently, central banks may have little choice but to maintain pressure on the brake pedal, even as the global economy slows. With an estimated $226trn of debt outstanding globally, rates are unlikely to rise as far as the 1980s. We believe a relatively modest tightening of financial conditions will deliver the reduction in end demand that policymakers require to ease inflationary pressure. We are therefore neutral on US 10-year government bonds at yields above 3%. In terms of asset prices, bond markets have moved ahead of central bank policymakers in 2022. Equities are adjusting more slowly to the new reality of slower growth, higher interest rates and a new-found emphasis on the most basic immediate needs – food and energy. Nevertheless, meaningful progress has been made on eliminating the most glaring valuation excesses of the post COVID-19 era.We maintain our neutral outlook on global equities but believe investors should remain highly selective and seek exposure to sectors that benefit from higher interest rates and stocks that represent defensive earnings streams. In an environment of normalising equity valuations we maintain the same strategy, which is to focus on traditional sectors such as energy, pharma, banks, insurance and defence, which have historically offered a degree of inflation protection while avoiding more overvalued segments of the global equity market, either by region or sector.

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