A trader works on the floor of the New York Stock Exchange (NYSE), June 27, 2022.
Brendan McDermid | Reuters
The first half of 2022 was a historic bleak year for global stock markets, and strategists believe there are dark clouds looming and there is some way to go before the storm blows.
The S&P 500 closed last week its biggest first-half drop since 1970, down 20.6% since the start of the year. The pan-European Stoxx 600 ended the halving 16.6% lower and the MSCI World Index fell 18%.
A host of other asset classes also saw significant losses, including bonds. The traditional “safe haven” US dollar and some commodities, such as oil, were among the few exceptions for six ugly months.
For investors, “The good news is that H1 is now over, and the bad news is that the outlook for H2 does not look good,” Jim Reed, head of global credit strategy at Deutsche Bank, said in a daily research note on Friday.
However, US stocks managed to rally as the second half started on Friday, and European markets had a positive day on Monday (US holiday).
However, the macroeconomic outlook remains uniquely uncertain as the war in Ukraine and inflationary pressures persist, prompting central banks to initiate monetary tightening and exacerbating fears of a global economic slowdown.
“The economic system is changing”
In a mid-year outlook report seen by CNBC, HSBC Asset Management advised investors that “the economic system appears to be changing” as adverse supply shocks persist, globalization slows, and commodity prices remain “secularly high”. And all this while governments try to manage the “transition risks” of changes in climate policy.
HSBC’s chief global strategist, Joe Little, has described the end of an era economists have dubbed “secular stagnation,” characterized by historically low inflation and interest rates. Going forward, expect more persistent high inflation, higher interest rates and more volatile economic cycles.
“Many of the investment markets tailwinds are now headwinds. This signals a phase of ongoing market turmoil. Investors will need to be realistic about return expectations, and they will need to think more seriously about diversification and portfolio flexibility,” Little said.
Emerging structural issues of deglobalization, climate policy and the commodity super-cycle will lead to more persistent inflation in major economies. Although HSBC expects inflation to gradually decline from current multi-decade highs in many economies, Little said the “new norm” is likely to be sharp price increases in the medium term, leading to to the point of rising interest rates.
To navigate this new era, Little suggested that investors look for greater geographic diversification, highlighting Asian asset classes and credit markets as “attractive income-enhancing factors.”
“Real assets and other ‘new diversifications’ can help us build resilience in portfolios. There is also a place to invest with conviction and objective strategies, where we can identify huge trends that are credible and affordable,” he added.
Dave Pearce, Utah-based director of strategic initiatives, told CNBC Friday that the macro forces in action mean markets are still “going in the wrong direction.” He stressed that inflation has not reached its peak yet and there is no clear catalyst for the return of oil prices to the ground.
He added that unless there was a solution to the war in Ukraine or oil companies were able to increase production – which he proposed would take at least six months and risk bottoming out in the oil market if Russian supplies were restored. The price pressures that drove central banks to take drastic action show no sign of abating.
Stock valuations have fallen significantly from their highs in late 2021, and Pierce acknowledged they are “more alluring” than they were a few months ago, but he still lags behind in returning to stock market positions.
“I’m not bringing all my eggs back to market at the moment, because I think we still have ways to go. I think there will be some additional paybacks that we will get in the market and I think that might be necessary.”
“When you have interest rates doing what they are, it’s really hard to keep things stable and work and go one way.”
Pierce added that the correction seen in recent months was not surprising given the “times of plenty” that markets enjoyed during the recovery from the initial collapse of Covid-19 to record levels late last year.
Regarding sector privatization, Pierce said he has turned his attention toward goods and “essentials,” such as healthcare, food and basic clothing.
Recession risks, but there is room for improvement
Although the investment landscape appears somewhat precarious, HSBC’s Little suggested there is room for improvement later in 2022 if inflation calms down and central banks can adopt a more “balanced” stance.
The bank’s asset management strategists believe we are now on the cusp of “peak pain” about inflation, but the data won’t drop significantly until late in the year. Little said his team is closely monitoring wage data for signs of entrenched inflation.
A tight monetary policy shift leading to recession remains the biggest threat to this outlook, Little suggested, but the exact scenario varies by geography.
“With the global economy now entering a somewhat later stage of the cycle, we are seeing more divergence between regions. At the moment, the outlook looks more dire for Europe and parts of emerging markets,” he said.
In light of recent market moves, few bond valuations have been identified as more attractive, and he said selective income opportunities have emerged across global fixed income, especially credits.
“We prefer short-term credit allocations, on a selective basis in Europe and Asia. Within equities, we also want to be more selective. We continue to focus on value and defenses but remain vigilant to the possibility of another pattern change, bonds should stabilize,” Little said.