From rising inflation to a recession: a look at what may impact the world
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From rising inflation to a potential recession, here’s what could impact the global investment landscape

From rising inflation to a potential recession, here’s what could impact the global investment landscape

The uncertainty seen globally calls for a much more selective investment approach and careful management of downside risks through proper diversification and suitable hedges in the months ahead

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Eli Lee, head of investment strategy, bank of singapore

Heading towards the second half of the year, fears that the world economy could slip into recession have investors perched on the edge of their seats. Investors face an increasingly difficult macro environment marked by ongoing disruptions from the Russia-Ukraine war and its effects on energy and commodity prices, and mounting concerns about China’s slowing growth given little clarity on when its strict zero-Covid policy might be relaxed. In the US, the Federal Reserve (Fed) is attempting to tighten policy swiftly to curb record-high inflation while engineering a soft landing for the economy.

We now see a 50-50 chance of a recession in 2023. There are early signs that higher rates and tighter financial conditions are beginning to form a drag on the economy. Real or inflation-adjusted yields have surged into positive territory due to expectations of rate hikes, and currently have exceeded the peak level in late 2018 when the Fed ended its last hiking cycle as conditions turned overly restrictive.

In the event of a recession scenario, we are cautious that the deterioration of corporate earnings could lead to a further downward trend in the value of global equities and credit.

A potential recession scenario would be driven by Fed concern over inflation. With relatively healthy balance sheets in the banking sector and limited candidates for a sizeable asset bubble crash, we think this bear market is less likely to show declines as deep as those in the 2000 and 2007 crises. Excluding these two outliers, the average post World War II bear market decline is 29 per cent and lasts for 11 months. Additionally, historical analysis of bear markets also shows that the market bottom on average occurs about six to nine months before a rebound in corporate earnings.

Overall, these analyses suggests that while we may not have reached a definitive bottom in equities, if a recession scenario takes place, at current levels we have likely already worked through a significant part of the peak-to-trough downside. Also, in a 2023 recession scenario, considering that a typical recession lasts for three to four quarters, we could see equities put in a bottom in the second half of 2022 or the first half of 2023.

China’s turning point
Closer to home, recent data in May suggests China’s economy may be picking up after slowing sharply since mid-2021 due to tight credit growth, power cuts, weak property and zero-Covid lockdowns.

Last month, exports, retail sales, industrial production, investment and credit growth all improved to the benefit of risk assets like equities. But the outlook remains challenging and we forecast GDP to only expand 4 per cent this year, after surging 8.1 per cent last year, as Beijing’s zero-Covid strategy keeps consumption subdued. However, policymakers are in easing mode, with credit expansion and fiscal stimulus already exceeding 2020’s levels. Increased policy stimulus should help put the Chinese economy on a gradual path to stabilisation in the second half of this year.

The Middle East stands strong, but this shouldn’t be taken for granted
The Middle East region has strongly benefited this year from elevated oil prices. Economic growth and domestic markets have been resilient in the face of sharply slower global growth.

The outperformance is likely to continue in the second half of 2022. However, challenges to the outlook are increasing. In particular, the Federal Reserve is set to keep increasing interest rates sharply while Europe is set to fall into recession as Russian gas supplies dwindle.

Investment strategy: Staying defensive
In our asset allocation strategy, we continue to advocate a broadly defensive approach, being overall underweight in terms of our risk stance. We are overall underweight equities. In particular, in developed market (DM) equities, where central banks are on tightening paths, we do not believe that a definitive market bottom has been made as the market calibrates valuations to rising rates and shifting recession risks.

We expect outperformance from companies that benefit from re-opening trends, companies that enjoy pricing power in an inflationary environment, and prefer value over growth. In Chinese equities, we expect short-term volatility to persist, but we see long-term value emerging amid depressed valuations, especially in sectors likely to benefit from policy tailwinds such as construction and infrastructure, materials, renewables, and telecommunications.

In fixed income, we also hold an overall underweight position, with underweight positions in DM and emerging market (EM) investment grade bonds, as we see duration risk to be a headwind with yields anticipated to rise further. Careful selection of individual credits is critical in this environment.

Finally, we believe alternative investments can serve as additional diversifiers against the headwinds over the near-term and contribute to better risk-adjusted portfolio performance over the medium-term.

Overall, the many sources of uncertainty globally call for a much more selective investment approach and careful management of downside risks through proper diversification and suitable hedges in the months ahead.

Eli Lee is the head of Investment Strategy, Bank of Singapore

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