What’s the market outlook amid inflationary pressures, slow growth?
Global investment management company T. Rowe Price's Head of Multi-Asset Solutions APAC, Thomas Poullaouec, and team remain underweight to equities and bonds and overweight to cash.
Sharing their latest views on global asset allocation and the investment environment, the team said key risks to global markets include central bank missteps, persistent inflation, potential for a sharper slowdown in global growth, China’s balance between containing the coronavirus and growth and geopolitical tensions.
Coming out of the annual Jackson Hole meeting, Fed Chairman Jerome Powell’s speech, unsurprisingly, had a strong tone reinforcing the Fed’s intention to fight inflation at any cost, a 180- degree reversal of his ‘inflation is transient’ tone delivered the same time last year, said the fund manager.
“But, just like last year when the Fed misread the growing threat of persistent inflationary forces and underacted, they may be misreading the trajectory of inflation once again.
Poullaouec and team suggested that although it is unlikely that inflation returns to the Fed’s 2% target anytime soon, it could be falling a lot faster than suggested by the Fed’s tightening, leaving markets to wonder if next year’s speech is about rate cuts.
Key market themes
While lingering supply chain impacts from the pandemic and the Russia- Ukraine conflict over the past year further exacerbated inflationary pressures, Poullaouec and team said we are now starting to see key input costs–such as oil, lumber, and copper–sharply decline, noted the fund manager.
Recent jobs data has also pointed to higher participation rates, which should help ease the tight labor market and pressure on wages and while other ‘stickier’ components of inflation–such as rents and owners’ equivalent rents–are still on the rise, the pace has moderated in recent months, they said.
Home prices surged over 40% since the start of the pandemic, but the market tides have unfortunately turned amid tighter Fed policy, as mortgage rates have spiked higher, with the 30-year fixed rate moving from below 3% up to 6% since early 2021.
That abrupt leap in rates has quickly stifled demand, sending prices and sales lower, and is already forcing some mortgage lenders to begin layoffs amid the downturn. “While there is clearly some excess in home valuations, particularly in certain regions that saw the strongest demand, it may be a stretch to draw parallels to the 2008 house of cards that came crashing down, as credit fundamentals of borrowers today are less of an issue. In fact, many buyers, and particularly first-time home buyers, have been sidelined as climbing financing costs are continuing to keep affordability out of reach and more than offsetting the recent softness in home prices.”
Where is Australia headed?
Future earnings expectations in Australia are becoming more cautious to reflect the weakening of the economic momentum, the team said.
Policy tightening in Australia is not over yet given inflationary pressures but consensus expects the Reserve Bank of Australia to moderate the pace of tightening going forward, reducing the pressure on yields rising, according to the fund manager.
The housing market has peaked as evidenced by prices and activity level but the demand for industrial metals has room to expand should China successfully stimulate its infrastructure spending. Consumer spending remains healthy despite the headwinds, Poullaouec and team said.
Where to invest?
Poullaouec and team remain moderately cautious on risk, through our underweight to equities and bonds and overweight to cash. Slowing growth and declining earnings remain a challenge for equities, while persistent inflation and higher rates could weigh on bonds. In T.Rowe Price's view, cash is an attractive alternative with higher short rates.
“Within equities, we are nearly balanced between value and growth. Slowing growth backdrop unfavorable for cyclicals, while higher rates weigh on growth-oriented equities.
“Within fixed income, although we remain constructive on floating rate loans, we took an opportunity and trimmed our overweight position in the sector as spreads have rallied sharply over the past month.”