Blog: You, us, everyone

The markets closed out the quarter mostly down on concerns of a) a lingering conflict on the border of eastern Europe, b) accelerating inflation, and c) recession. As we roll into the 3rd quarter, all major indexes have flirted with or succumbed to bear markets. A bear market is generally defined as when an index or an asset’s price has declined more than 20% from a recent high.

Whether or not the S&P 500 is in a bear market is mostly a matter of semantics, observation periods, and calculation methods. On a closing basis, this benchmark entered into the bear market on June 16, 2022; however, when intraday prices are considered, the index slumped into a bear market about 2 weeks earlier. Finally, when considering market performance plus dividends, then only very the actual bear market started. Yet, surprisingly, the Dow Jones Industrial Average (DJIA) snapped an eight-week losing stretch, its longest downdraft in nearly a century.

The question now is whether or not the late May rally signals that the worst of the sell-off is over. Inflation could be plateauing, and the focus of market worries appears to be shifting to economic growth, particularly as the Federal Reserve is committed to keep raising interest rates at a fast pace.


Rumbling about inflation
Speaking of inflation, Wall Street banks have been trotting out predictions for when the next recession could start. For now, the general consensus is that an economic downturn is more likely to begin sometime in 2023 ­– which may explain why traders have punished stock prices in recent months. In general, market behavior foreshadows an event six months in advance.

Looking ahead, we will be watching what stocks and other asset classes are leading the way into a recovery. For now, we consider it too late to switch to value and too early to enter the sovereign corporate bond market world. There are some bond segments (such as GCC and Asia) in which we consider the corporate and sovereign market to be solid for the next three to four years.

Finally, we highlight that each and every economic cycle ends in some type of recession. The next one is expected to have a very different flavor than the Covid Recession or the Great Recession, but one thing we can say for sure is that we do not know when it will happen. Key indicators include the evolution of the housing market and the net personal savings rate, a ratio already at its lowest level since the Great Recession.


Areas of Opportunity
Despite lower expected returns for 2022 and 2023, there are still openings for all types of investors. Let’s drill down into the most valuable opportunities in the market:

• US Value Stocks: Although we continue to favor growth stories related to secular growth trends in the field of Next-Gen Connectivity, global value stocks offer a reasonable short-term opportunity. On the back of a prolonged period of higher-than-expected inflation, these companies could potentially offer value buckets providing outperformance for a given period of time. Consider looking at companies that have corrected far below the historic price level, such as PM, MO, and WMT.
  
  U.S. Growth Stocks: Year-to-date, well-established mega-cap technology stocks have underperformed the broad market. Currently, many of these technology companies – most of which are cash-rich and can endure a prolonged period of lower-than-expected revenues streams – are trading at attractive valuations. The most valuable opportunities are related to companies operating in the field of connected devices – from electric vehicles to smart-home devices and medical monitoring systems. All these enablers are still grappling with a shortage of semiconductor chips, a deficit expected to extend well into 2023. As a result, the pricing power will be relatively high.
• Europe: It is true that European stocks are cheaper – most of them have a strong value bias. Pending geopolitical developments, European equity markets may continue to remain cheap. Long-term investors may consider engaging with companies in the energy and materials sectors, which should be booming on the back of the oncoming disruption of the demand-offer conditions in the sector.
  
  We expect European markets to experience a challenging and dramatic future ahead. The Green Energy deal – launched in the aftermath of COVID – is by definition a good thing. However, its implementation will take time. Currently, with a series of politically driven measures such as the exit of all fossil-fueled car engines by 2035, it appears Europe could be "going green" even earlier than expected. With no valid alternative currently in place, R&D still needs at least 5 to 7 years to create a valuable and scalable solution. Any such solution would need to be ready as soon as 2030, in order to give the industry time to implement and build the whatever new facilities are needed.
  
  More importantly, member state finances will be impacted in one way or another. For instance, France collects about €42 billion annually in taxes on fossil oil sales. Besides the evaporation of future revenues represented by the shift to green energy, debit interest charges will increase again by around 2025/2026, adding additional pressure on already financially and economically weak members such as France, Italy, Spain, and Portugal. Can they really implement this policy on par with stronger members? We doubt that very much!
  
  Long-term investors should immediately position themselves for these upcoming events. Sectors that may perform throughout this period include: energy (leaders in the energy transition), materials (building new infrastructures), and utilities (higher volume output); while red-flagged sectors include: financials (loan losses), low level consumer discretionary (lacking spending power), and healthcare (reduction of government subsidies).
  
  
• Asia ex-Japan: Because Asian governments have greater involvement in directing prices of prime products than elsewhere, inflation is perceived differently. In addition, consumer spending is still somewhat limited because of ongoing COVID restrictions. However, on the positive side, supply chain disruption is less of an issue in Asia than in Europe or the United States. Although the broader region has underperformed the global market by about 30% since 2016, we still believe Asian markets are currently a suitable opportunity for assets that do not need to be invested in Europe or the US
  
  Finally, we note that China is changing its COVID policy. Up to now, policy favored vaccination of the active population (20 to 55), while the older generation was put on hold. However, statistics have demonstrated that COVID cases occur mainly in the 55+ segment. Mainland China has, according to official figures, administered more than 3.39 billion vaccine doses so far. Assuming every person needs a minimum of 2 doses, the vaccination rate is technically above 120%. However, given that a single shot of SinaPharm vaccine has an efficacity of less than 45%, the vaccination ratio may be considered low when compared to others. Obviously, there is no one statistic that can conclusively demonstrate that China's zero-COVID policy is actually expediting a return to pre-COVID life.
  

• Credit: In the coming weeks, geopolitics are likely to impact credit spreads, but we do not expect this to persist for a prolonged period of time. This impact occurs on the back of a largely positive credit momentum, reflecting favorable financing conditions and a powerful economic recovery. Longer term credit risks include persistently high inflation and market volatility, which would undermine a regular market evolution, particularly for the more leveraged corporates, as well as some emerging markets.
  
  We favor credit in regions which benefit from strong commodity price trends, such as Oman, Emirates, Saudi Arabia, and some Asian countries.