Focus: Investment strategy
13 June 2022
By Julien Lafargue, London UK, Chief Market Strategist
The first six months of 2022 have been testing for investors, as the post-lockdown reopening euphoria led to a painful hangover. While we are not out of the woods yet, the road ahead is, in our view, gradually opening up. Many opportunities are emerging too. However, the watchword for the next six months remains one of caution, and ensuring portfolios are diversified properly to achieve their long-term goals.
The first six months of the year has been challenging, to say the least. The normalisation process we highlighted in November’s Outlook 2022 happened much faster than expected as major central banks woke up to the risk of runaway inflation. The war in Ukraine also significantly changed the mood that was prevailing at the start of the year.
With financial markets bouncing around violently, cross-asset class correlations shifting, and a striking lack of visibility, the one element that hasn’t normalised is volatility. This, we thought, would be a key feature of 2022 and one that might require investors to diversify beyond a traditional 60/40 split between equities and bonds. On this particular topic our view hasn’t changed.
However, looking to the second half of the year, we acknowledge that the macro backdrop has deteriorated. We now expect lower growth and higher inflation, globally, for the remainder of the year. The next few months will likely see central banks remaining hawkish, as they try to restore credibility before eventually confronting the reality of a weakening economic momentum.
That being said, contrary to the markets’ prevalent “doom and gloom” mood, our outlook remains constructive. Although growth is slowing and could even turn negative temporarily in parts of the world, it should remain broadly in line with trend this year and next on a global basis. Similarly, inflationary pressures seem to be peaking. Sure, the return to “normal” isn’t going to happen overnight, but data suggest the worst is most likely behind us.
Importantly, and after the difficult last few months, much bad news appears to be already in the price. Markets tend to be forward looking and to react to the second derivate (that is, the rate of change) and not to levels. In other words, slow but steady growth tends to be much more supportive than when it is high but decelerating.
The wall of worry facing investors is steep and, unfortunately, will likely to take some time to surmount. Indeed, whether it’s the risk of a policy mistake, geopolitical tensions and their consequences, or the slowdown in China, none have a quick or straightforward solution. Instead, it will probably take months for investors to become more comfortable around these issues.
As a result, market gyrations will likely persist, challenging investors’ resolve. In this context, it’s critical to tone down the noise and let long-term plans and goals dictate portfolio allocation.
With both bonds and equities having suffered losses so far this year, achieving investment goals is becoming tougher. While we expect both asset classes to recover, investors will need to find additional sources of returns in the months and years ahead.
In our view, private markets should be considered as a prime candidate for this. Giving up portfolio liquidity may be daunting, but it can boost returns (due to the meaningful reward available through their illiquidity premium) and preventing rushed, and possibly ill-advised, investment decisions.
Similarly, in the apparent chaos, there are pockets of calm that offer the visibility investors crave. Whether it’s the ongoing energy transition, the growing digitalisation of our economies, or the need for improved infrastructure, focusing on such secular themes can be a source of both returns and peace for investors.
Barclays Private Bank’s views (please see our asset allocation page for more details):
Inflation: We are at, or near, peak inflation and prices increases. While inflation is likely to remain above pre-pandemic levels, it should gradually moderate in the coming months.
Recession: A mild recession is possible in the US and probably in parts of Europe. Yet, a temporary period of contraction isn’t necessarily the precursor to a crisis.
Rates: Central banks are trying to restore their credibility and the era of free, abundant liquidity is probably over. That being said, with inflationary pressure gradually abating, we believe that the hawkishness seen from central banks in the first half of the year won’t be repeated.
Fixed income: With the recent increase in yields, opportunities are emerging to lock in rates. We remain mindful of possible further spread widening in credit and would proceed with caution, especially in high yield debt. BB-rated bonds appear to offer the most attractive risk-reward.
Equities: Volatility will likely continue until the growth and inflation outlook improves. Although earnings expectations appear too optimistic, upcoming downgrades are already reflected in valuations. In this context, diversification remains key. We see opportunities in both cyclicals (banks and industrials) and defensives (healthcare).
This month we take a look at the major trends at play in the financial markets and the implications of surging inflation, central bank rate tightening, and slowing economic growth prospects. We also look at how private markets might be needed to bolster diversification, and what investors can do to limit the effect of what may continue to be a volatile end to the year.