Three investment themes that will dominate Q3
Surging inflation, hawkish central banks and the war in Ukraine have dominated global markets through the first half of 2022. In response, central banks have sought to strike a balance between reducing inflation by tightening financial conditions and mitigating the impact on economic growth. This quarter may prove to be a turning point in that approach.
Inflationary pressures have intensified, and supply chains are being redrawn. We see this as the start of 'the Great Reset', in which the Federal Reserve (Fed) leads central banks down a more hawkish path that prioritises managing inflation above a soft landing.
As a result, downside risks to global growth have increased exponentially. Given its greater exposure to the war in Ukraine and vulnerability to deteriorating gas flows from Russia, recession in Europe now looks to be likely, while the US too has edged closer to a hard landing scenario.
We expect three key investment themes to dominate the third quarter.
1. Hard or crash landing
As recently as March, it seemed possible that central banks could engineer a soft landing by front-loading rate hikes and then readjusting mid-course. With inflation edging higher throughout the subsequent quarter, however, the question has become how hard the landing will be.
This pivot was marked by the Fed’s decision to match its hawkish rhetoric with hawkish action: a 75bps rate hike in June could well be matched by a further 75bps in July. We believe that the European Central Bank (ECB) and Bank of England (BOE) are likely to pursue a shallower hiking path, due to their economies’ increased exposure to the Ukraine War and greater risk of recession. Nevertheless, the risks to global growth are clear. We have increased the likelihood of a hard landing scenario, in which central banks push the economy into a recession (either accidentally or on purpose), from 35 per cent to 60 per cent.
2. China re-emerges from lockdown
China is an outlier. Navigating a different stage of its economic cycle from most other countries, it’s also pursuing a markedly different Covid strategy. Its Zero-Covid Policy (ZCP) placed many major cities under severe lockdowns, most notably Beijing and Shanghai. These generated a short but sharp economic downturn through April and May.
China’s re-emergence from the spring lockdowns is a clear positive for its economy, but many indicators suggest caution is still warranted. Primary property sales are well below previous levels, while unemployment (particularly among the youth) is rising, causing concern for a government that is focused on social stability. This is particularly important in the run up to its 20th Party Congress.
Similarly, while China’s fiscal and monetary policy is increasingly supportive, its ultimate effectiveness and the nature of consumer sentiment post-lockdowns remain unknown.
It’s also yet to be seen whether China’s economic recovery will be strong enough to offset slowdowns elsewhere in the world. That said, likelihood of China decoupling from the rest of the world in H2 is gathering momentum.
3. The global consumer is put to the test
The global consumer has a lot on their plate. Many are already feeling the inflationary pinch, with cost-of-living crises and diminishing purchasing power providing major headwinds. Real wages are falling, and mounting discontent is being reflected in record low consumer confidence indicators across the globe.
In parts of the world, what consumers are doing is yet to reflect what they’re thinking. Though US consumer sentiment has plunged in recent months, retail sales remain resilient, buoyed by stimulus-laden bank accounts. With mortgage rates rising and affordability metrics plummeting, we believe that low confidence levels may soon translate into diminishing activity levels.
The Chinese consumer too faces headwinds, with ZCP restrictions still fresh in the mind and unemployment on the rise. Any further lockdowns would prove a further blow to consumption.
Ultimately, we believe that the resilience of the global consumer in the face of rising costs and tightening financial conditions could prove key in determining the severity of the economic landing.
As well as outlining the three themes, we consider their key investment implications across different asset classes in a matrix.
This quarter may prove vital in determining the trajectory for markets and economies over the next few years.
In this rapidly changing environment, our focus is on managing risk coupled with mapping the medium-term implications of “the Great Reset”. At the same time, periods of uncertainty may create opportunities for individual companies across a range of sectors, some exposed to long-term trends that were previously overbought, others overlooked during the rush for growth.
*Andrew McCaffery, Global Chief Investment Officer, Asset Management, Fidelity.
He joined Fidelity International in July 2019. Prior to this he spent 8 years at Aberdeen Standard Investments in a range of senior roles including Global Head of Strategic Client Investments and Global Head of Alternatives.
Andrew has over 30 years’ industry experience across investment, risk management and client distribution.