Most central banks have started to normalise policy as inflation soars, despite the slowing economy. Hence, economic growth has become a scarcity again.
Q1 2022 was a disaster for bondholders. Safe-haven bonds, such as US Treasuries, turned in the worst performance in more than 40 years (see ‘number of the week’). This is mainly due to central banks’ tightening policy given persistent inflation shocks, despite the slowing economy. As an investor, you would like to see central banks normalising their policies going into a strong demand-driven economy and staying on hold when the cooling off takes place.
Growth has already been slowing
This time the heat is on as inflation gauges go through the roof due to supply-side constraints and commodity price shocks. Moreover, growth has already been slowing considerably. The US labour market is a case in point: it is red hot and glowing, as supply there is super tight while demand recovers further. Yet the US economy is down to merely 1.5% growth for the quarter, according to the Atlanta Fed indicator. Other reasons, same effect: China is struggling with its zero-Covid-19 strategy and sees the gap to its declared growth goals widening. We currently pencil in 4.7% growth for 2022, versus the bar set at 5.5% by Chinese authorities earlier this year. And there is hardly any sign of a policy response apart from rhetoric here and there.
Conclusion for investors
Thus, the post-pandemic recovery has ended for good, and investors find themselves in an adverse mix of sluggish growth at high inflation rates (i.e. ‘stagflation’) until further notice. Interestingly, when brainstorming within the research team, most of the best ideas come from the growth camp. In a way, the label ‘growth stocks’ is misleading, as growth stocks do best when growth is low. In other words, growth stocks are the flavour of the day when the economy is weak overall. This has been the environment for most of the past decade, and growth stocks have done well. But aren’t interest rates a killer for growth names? That has been the reasoning so far, since investors still think of growth stocks as having a lot of their valuations in the distant future.
However, this is challenged by higher current rates. Firstly, a lot of the adjustment has taken place by now, and secondly, investors are looking for pricing power, which most growth names provide as inflation soars. Time to buy back some growth.
Number of the week