June 21, 2022
This year’s road trip has been more than bumpy
In “Our outlook for 2022,” we drew comparisons between the path for market returns and that of a family road trip. The journey would have both expected and unexpected pit stops along the way, but the end destination can likely be positive.
What had been expected was the start of the pivot in global central banks’ monetary policies from ultra-accommodative to tightening. What was unexpected was that the pivot and market expectations would be toward an ultra-restrictive monetary policy in the form of above-average interest rate increases.
Further, the war in Ukraine and its impact on energy and food prices, along with the implementation of a zero-COVID policy in China and its added impact on supply chain disruptions, have also been unexpected but material pit stops.
As investors, it’s easy to focus on the past, given the volatility across nearly all asset classes, but it’s important to keep the focus on the road ahead, as that’s what’ll likely lead us to our desired destination.
Capital Markets Strategy team's outlook—a snapshot
"If you make the mistake of looking back too much, you aren’t focused enough on the road ahead of you."
— Brad Paisley
Is a recession around the corner, and if so, how deep will it be?
We’re optimistic that a focus on policies to reduce inflation, the end of government support programs, and improvement in previous supply-demand imbalances could help ease inflationary pressures in the second half of the year and into next year. Inflation levels don’t have to come down materially, but evidence of a continued reduction must be present. If we’re proven correct, the chances of a deep, consumption-driven recession will reduce and the odds of a milder slowdown will increase.
Equity markets caught up in the perfect storm
While it’s near impossible to call the bottom of the market, there seems to be a lot of negativity already factored into the current equity markets. The proverbial market pendulum seems to have swung pretty far. Should we get any moderation in the negative sentiment, we could see a positive reaction in equities. Whether we look back at this period and classify it as a big bear or baby bear, these are often attractive entry points for investors with patience to withstand additional short-term volatility, as the bull markets that follow tend to be stronger and longer lasting.
Fixed Income—a light at the end of the tunnel
We think bonds, for the most part, remain a misunderstood asset class—and for good reason, as it’s a complicated one. Although difficult, we need to ignore the recent performance and look ahead to determine where the opportunities exist in fixed income. When investing in bonds, it’s not always just about comparing yields but also looking at how the different types of securities perform toward the end of the economic cycle. If we’re in the latter stages of this cycle, longer duration, higher quality bonds tend to outperform, as their prices tend to rise as the expectation for a recession increases.
In keeping with our process, with reasonable current equity valuations but an increasing risk of a shallow recession at minimum within the next 18 months, we‘re slightly altering our asset allocation. As of June 30, 2022, the Capital Markets Strategy illustrative portfolio remains overweight equities at 65% (+5% to benchmark) and 35% to fixed income (–5% to benchmark). The portfolio is well balanced across equity geographies. Throughout the past couple of years, we’ve been advocating rebalancing portfolios to target asset allocations and dollar-cost averaging into this market. We continue to emphasize that approach today.
May 16, 2022
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