Dear Investors,
Wellington Management – Is the world changing?
“Macro-economic cycles are likely to be more extreme, frequent and compressed, as central banks become an additional source, rather than a compressor, of volatility.”
“A key macro implication of that finding is the likely greater cyclical divergence between countries and the need for different central bank responses.”
3 main challenges financial markets over the last decades
“Global growth has been an expression of the US consumer – Global growth has converged significantly since the late 1990s, with the forming of a clear supply chain.”
“The US has been the dominant buyer of consumer goods from China as well as capital goods from Germany and Japan.
“As a result, when the US cycle turned, the rest of the world generally followed with a lag.”
“Capital flows resulting from globalisation have forced central bank policy convergence.”
“In the US-consumer-led globalisation era, if a central bank moved too far away from the Fed, the currency appreciated and effectively acted as a drag on export growth.”
“Going forward, we think monetary authorities’ attitude to currency strength will change when inflation is high rather than perceived as dangerously low.”
“Lack of independent thinking among central banks.”
“Major central banks outside the US have become used to following the Fed’s lead and mirroring the Fed’s reaction function.”
“This may not be an issue in a low-inflation era, but it will become much more difficult to hide within the “herd” in today’s world.”
“Especially when some countries’ inflation is running high.”
“Europe, for instance, is far less impacted than the US by the recent turmoil in the banking sector.”
“ECB in particular has more ground to cover before it is ready to pause rate hikes.”
“By contrast, US economy suggest to us that the Fed is near the end of its hiking cycle.”
Barclays Private Bank – Are financial markets remains constructive?
“At a time of slowing growth, persistently high inflation, even if easing, and interest rates that are nearing a peak, investors and the authorities will need to tread carefully.
“Diversification remains key.”
It’s not going to be easy
“That being said, the rest of the year is unlikely to be a smooth ride.”
“Equity valuations leave limited room for error, at least when compared to historical levels.”
“Bottom-up analysts continue to expect solid earnings growth despite a worsening macroeconomic picture.”
“Meanwhile, bonds remain highly volatile and cracks are appearing in the real estate market.”
After the storm comes the calm?
“After the turmoil of muti-decade high inflation and the steepest hiking cycle since the 1980s, policymakers will assess the impact of easing price pressures.”
“Rate moves and the extent of the slowdown on the economy.”
“Consumer activity in most advanced economies is likely to be depressed over the rest of the year.”
“Disposable incomes are further squeezed, saving rates rise and the tailwind from additional pandemic savings fades.”
“Peak price pressures seem to be past in major economies and are expected to ease towards the central bank target levels over the next 12-18 months”
“As inflation continues to moderate, labour markets cool and activity slows, the Fed should flip to an easing stance next year and deliver 150bp of cuts.”
Mild recession on cards for 2024
“America’s growth is expected to come under pressure in the second half of this year and through 2024, in the face of tighter financial conditions, easing domestic demand and a prolonged slowdown in manufacturing activity.”
“The economy is forecast to grow by 1.2% in 2023, then shrink for three consecutive quarters from Q4 this year.”
“Resulting in a 0.3% contraction in 2024.”
Long term view
“After a surprisingly positive start to the year for equity markets, there is now a significant disconnect between what the equity and bond markets are pricing in.”
“Equity markets have been very resilient in recent months, and certainty more resilient than many market participants had anticipated given the uncertain macro backdrop.”
“Global equities had rallied 21% from their October lows by 2 June and are back to their February highs.”
“Interestingly, most of this performance was achieved before the start of the quarterly earnings season in mid-April.”
“While corporate profits were generally better than feared in the US and Europe, they came on the back of lowered expectations.”
“Corporate guidance was not strong enough to provide an additional impetus to markets.”
However, the long-term outlook for equities remains constructive
“While the risk-reward for equity markets looks mixed in the near term, the longer term picture is more positive.”
“Stocks likely to outperform bonds meaningfully over a 10-year investment horizon.”
“Historically, cyclically-adjusted price-to-earnings (CAPE) ratios have been reliable indicators of long-term expected returns.”
“At current levels, CAPE ratios suggest that global equities could generate annualised returns of 8% in the next 10 years, including dividends.”
“While slightly below the 9% total returns posted in the past two decades, those returns are well above global bond yields of 3% at present over a similar period.”