International - Market Stories - H2 Outlook

Life above zero: Investors journey at a time of rising rates


Investors will have to navigate a fragmented world of slowing growth, higher inflation and increasing divergences between regions and sectors.

Key Takeaways


High fragmentation and a new policy mix will dominate H2 investment landscape

In an environment where global trade is no longer the main driver of growth, investors should look for resilience and seek to exploit opportunities that may arise from de-synchronised economic cycles.

Stagflation risk is on the rise


Stagflationary risks are on the rise, with real growth below potential and inflation above central bank targets.

 

Stagflationary risks appear widespread, with real growth falling and inflation remaining consistency higher than central bank targets. While a soft landing is still a possibility in the U.S, the euro zone looks much more fragile as it bears the brunt of rising energy prices.

Inflation has likely peaked but price pressures should continue to be felt due to supply-chain bottlenecks, high energy and food prices. We believe a full normalization of monetary policies is not on the cards as central banks try to balance out the need to tame inflation with that of preserving growth.

In this environment, policy mix dynamics and the extent to which central banks are prepared to accommodate additional fiscal stimulus will be key: while the US has almost no fiscal leeway ahead of mid-term elections in November, we could see targeted accommodation in China.

Key themes for the global economy in H2 2020


Global economy is slowing, due to the Russia-Ukraine war’s fallout, persistent supply bottlenecks and China’s zero-tolerance Covid-19 policy. At the same time, inflation is high and sticky across both DM and EM, boosted by high commodity prices.

Global economy is slowing, due to the Russia-Ukraine war’s fallout, persistent supply bottlenecks and China’s zero-tolerance Covid-19 policy. At the same time, inflation is high and sticky across both DM and EM, boosted by high commodity prices.

The policy mix will need to find a new balance as most DM CB have embarked on rate hiking cycles or will start soon, removing the Covid-19-era policy accommodation. Fiscal deficits will fall but should remain above pre-pandemic levels. Cooperation between monetary and fiscal policy will also be required to address the issue of debt sustainability.

The policy mix will need to find a new balance as most DM CB have embarked on rate hiking cycles or will start soon, removing the Covid-19-era policy accommodation. Fiscal deficits will fall but should remain above pre-pandemic levels. Cooperation between monetary and fiscal policy will also be required to address the issue of debt sustainability.

The ongoing war in Ukraine will have long-lasting consequences on the global geopolitical landscape and international alliances. US mid-term election in November will need to be watched carefully, as the Democrats may lose control of Congress.

The ongoing war in Ukraine will have long-lasting consequences on the global geopolitical landscape and international alliances. US mid-term election in November will need to be watched carefully, as the Democrats may lose control of Congress.

Russia-Ukraine war will further exacerbate divergences. Accordingly, the CB response will vary across the block. Commodity exporters and countries with policy room are favoured. China’s economy is close to a turning point due to policy accommodation, but is still impacting some Asian countries.

Russia-Ukraine war will further exacerbate divergences. Accordingly, the CB response will vary across the block. Commodity exporters and countries with policy room are favoured. China’s economy is close to a turning point due to policy accommodation, but is still impacting some Asian countries.

Investment Convictions: Building portfolio resilience amid stagflation risks


Investors are entering a period of great divergence

  • Stay neutral on risk and play the key themes from the great divergence.
  • Seek entry points throughout the year in China, EM and European equity to benefit from the bottoming out of these assets.

After the great asset repricing in the first half of the year, the strong relative equity appeal versus bonds has eroded, and a more balanced allocation is appropriate.

Equities

  • In equity investing, value, quality and dividends should be a good mix, as dividends represent a stable component of returns when inflation is high
  • US equities appear more resilient than EU stocks despite rich valuations, while Chinese equities, with the economic slowdown and earnings downgrades already priced in, could afford positive surprises.
  • EM equity offers attractive valuations compared to DM peers, offering interesting entry points for investors. However, selection is paramount in a fragmented world.

Fixed income

  • In fixed income, investors should move tactically to a more neutral duration stance and play divergences in monetary policies, as well as look to inflation-linked securities and floating rates for protection against inflation.
  • Corporate fundamentals are robust and the default outlook looks benign overall. However, sentiment is fragile in light of the risks around economic growth and rising inflation, as shown by widening HY spreads. As such, investors should be selective, focusing on quality and low-leverage corporates.
  • EM spreads have widened amid geopolitical tensions, offering an interesting entry point in terms of carry. We favour hard-currency bonds as they should be less vulnerable to monetary policy normalisation.

Cross Assets

  • In more unstable cross-asset correlation dynamic against the inflationary backdrop will require investors to seek additional diversification in commodities, currency strategies in particular those favouring currencies from commodities exporters, and alternative strategies with a low correlation with equities and bonds, such as Real assets. In that space, we favour real estate and floating private debt.
Mortier Vincent
The era of ultra-low and negative interest rates is over. This will continue to clean up excesses in liquidity-driven areas of the market - Spacs, cryptocurrencies, ultra-growth stocks - and will refocus investors on fundamentals, corporate leverage and earnings. Uncertainty regarding the evolution of the policy mix and on the geopolitical front will continue to keep volatility high, across the board.
Vincent Mortier
Group CIO of Amundi

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