Since the pandemic hit, the global economy has been in flux: first a flash recession, then a speedy recovery. So what can we expect for the rest of the year? We think a mid-cycle slowdown is next. But with the first proof that inflation is temporary, and promising economic growth data, we look forward to solid growth trends and with that…plenty of opportunity.
- With the Covid-19 pandemic, we have undoubtedly experienced something unprecedented – a virus outbreak that crippled economies around the globe and was followed by a flash rebound, thanks to vaccination efforts and supportive macroeconomic policies.
- We are now moving towards the next step: a mid-cycle slowdown. What may sound rather negative at first basically just means that, after a phase of record economic growth rates, we are entering a phase of moderate growth that still offers investors attractive opportunities.
Economic growth will be supported by pent-up demand being released into the economy and by productivity gains, the latter of which will likely offset the declining labour-force growth. We also believe that the support from macro-economic policies may wane later than many market participants expect, as policymakers will seek to keep financing conditions favourable by preventing interest rates from rising disproportionately. Of course, inflation will remain top of mind, considering the strong post-pandemic growth rates and the steeply rising costs along many supply chains. However, we reiterate our view that those inflationary pressures are only temporary in nature and will taper into 2022.
A closer look at equities
Throughout the rebound phase, equity markets have repeatedly reached new all-time highs, despite growing concerns about the Covid-19 delta variant and a possible removal of accommodative monetary policy. The strong recovery in economic and earnings growth has provided plenty of support to equity markets. However, global growth momentum is likely peaking, and we now expect a slowdown in the global economy that will last into 2022. The ‘mid-cycle slowdown’ phase has historically been accompanied by lower equity returns and lower earnings revisions, when compared with a high-growth environment.
- Against this backdrop, our research analysts believe that investors should consider tilting their equity portfolios towards more defensive and growth stocks, favouring quality names within the healthcare and information technology sectors. Combined with some financials, this would be a good way to maintain exposure to equity markets as the US Federal Reserve starts to slowly withdraw its policy support.
From a country perspective, US and Swiss equities could be considered, since they offer both defensive and growth characteristics.
As for emerging market equities, they have lagged developed market equities significantly since the beginning of the year. Amid low vaccination rates, emerging market countries have had to impose renewed mobility restrictions due to the fast-spreading delta variant. While uncertainties arising from political noise, virus mutations, and local reopenings dominate in Latin America and the CEEMEA (Central & Eastern Europe/Middle East/Africa) region, recent regulatory developments in China call for caution as well. Since we believe that emerging markets will take longer to return to their pre-crisis path of economic growth than developed markets, we have an ‘Under-weight’ rating for the segment and believe that selectivity will remain key going forward.
In emerging market equities selectivity will remain key going forward.
A word on the other asset classes
In a mid-cycle slowdown, the opportunity set for investors quite naturally shrinks, as the ‘tide’ (i.e. coordinated fiscal and monetary policy) becomes weaker and does not lift all boats anymore. We therefore suggest that investors remain invested and look out for opportunities if and when they arrive.
In fixed income, we expect markets to become more volatile in the months ahead, with markets pondering the timing and severity of monetary policy tightening. We therefore consider strategies based on active duration management to be the most promising. In addition, investors are well advised to become more selective and to avoid so-called ‘zombies’ (i.e. companies that earn just enough money to continue operating and servicing debt but are unable to pay off their debt), as the best in the corporate bond rally is probably behind us.
As for currencies, we believe that US dollar weakness will resume, as the growth advantage shifts from the US to the eurozone. In addition, a broadening global recovery may revive investors’ risk appetite, which is a headwind for the US dollar. Both effects should be able to overturn the US interest-rate advantage.
Finally, commodity prices remain at multi-year highs, with support coming from all directions: the economy, sentiment, and various wild cards. But bullish sentiment, anecdotes of hoarding, and, specifically, the fact that no serious harvest was missed suggest that commodities are close to or at their peak. We believe that talks of supply shortages are exaggerated, which justifies our cautious view on commodities overall.
Which topics will be relevant in the upcoming four months? Julius Baer experts share their views on the economy and financial markets