Wellington Management
June 21, 2022
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Multi-Asset Outlook — Sticky inflation, weaker growth: A volatile mix

The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

By: Nanette Abuhoff Jacobson, Global Investment and Multi-Asset Strategist; Supriya Menon, Multi-Asset Strategist

Key points

  • Weaker growth is coming. Given higher interest rates, worse manufacturing data, and a potential squeeze on corporate earnings and multiples, we prefer a moderate underweight to global equities versus bonds. 
  • Within equities, we think fundamentals favor the US and Japan over Europe and emerging markets. Weakness in China’s economy will weigh on Europe (as will high energy prices) and on emerging markets broadly. 
  • Market worries seem to be shifting from stagflation to weaker growth, which could make defensive fixed income in the US attractive from a yield, spread, and diversification standpoint while leaving spreads in growth fixed income looking vulnerable. 
  • We continue to see a case for diversified commodities exposure given structural inflationary pressures that will more than offset weaker demand from a slower global cycle. 
  • Downside risks to our views include a recession, a liquidity-related market failure, and an escalation in the Russia/Ukraine conflict. Upside risks include a soft-landing scenario — where the Fed tightens policy just enough — and a positive policy surprise in China.

Despite the steep stock market sell-off already this year, we see three reasons to believe the backdrop will remain negative and warrant a moderate equity underweight for the next 6 – 12 months: 1) the reversal of accommodative monetary and fiscal policy, 2) persistently high inflation, and 3) the risk of lower corporate earnings and multiples. The US equity market, where valuations are still fairly high, might well be feeling “ghosted” by the Federal Reserve, with Chairman Powell having all but said the central bank will not come to the market’s rescue and will be looking for the economy to pass longer-term inflation tests before taking a less hawkish stance. On the other hand, the US entered this challenging period in a strong position, with healthy household and corporate balance sheets, and Japan has the advantage of attractive valuations. Thus, we prefer a moderate underweight to equities, rather than an all-out underweight, and we favor the US and Japan over Europe and emerging markets.

sticky inflation weaker growth a volatile mix mao

Turning to the bond market, we have raised our view on defensive fixed income from moderately underweight to neutral. We think market worries are shifting from stagflation to weaker growth, yet fed funds futures are signaling more rate hikes than the Fed’s hawkish forecast. Higher yields of around 4.5% in high-quality bonds mark a departure from the return-free rate environment, and we think slower growth and the market’s expectations will limit future spikes in rates. We still have a moderately underweight view on growth fixed income, with no tilts in any of the underlying sectors (as shown in our “Multi-asset views” table). We remain bullish on commodities, though we have taken our view down a notch to moderately overweight, reflecting our belief that the cycle may put a slight damper on demand but structural issues limiting supply in energy and metals will prevail. 

Equities: Favoring Japan and the US over Europe and emerging markets

We maintain our moderate overweight view on Japan and the US. Japan’s valuations are the most attractive among major developed market regions ( Figure 1 ) and its weak currency is an advantage. In contrast to many peers, Japan should benefit from higher inflation, given its secular backdrop of persistent deflationary pressure. and its market is under-owned by global investors.

Figure 1

sticky inflation weaker growth a volatile mix  fig1

With the Bank of Japan steadfast in its defense of yield-curve control even as other central banks tighten, Japan has a more supportive policy mix than other regions. Taking this into account, along with clearer evidence of improving corporate governance and low valuations, we expect Japanese equities to continue their year-to-date outperformance against other regions on a local currency basis. 

US stocks have been particularly exposed to the recent sell-off due to a bias to tech and expensive growth stocks, which are higher duration in nature. This repricing may not be over yet, but amid global growth risks, the US market could have an edge, being relatively more defensive in nature versus other regions, especially in an environment of heightened geopolitical uncertainty. 

Europe has higher leverage to the global cycle and a more fragile growth backdrop given China’s struggles. We maintain our moderate underweight view on the region, as tighter financial conditions begin to...

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