House Views - May 2022: At the crossroads
AT THE CROSSROADS
Rampant uncertainties, mismatched economic cycles and complex choices on economic policy. Our baseline economic scenario still has growth moving back to normal as we emerge from Covid. However, global prospects look to have weakened and remain highly uncertain as geopolitical tensions continue to run high. Also, the economic cycles in the world's regions seem to be drifting out of synch. The United States can look forward to a stronger growth trend, possibly tipping into overheating in some sectors. Europe, though, will be held back by the direct impacts on its energy supplies from the Ukraine war. Asia will slow more sharply than expected, partly due to ongoing Covid measures damping down activity. Other emerging economic regions will be held back by continuing high prices of commodities and food. In these circumstances, economic policy-setters will have to make some difficult choices. Monetary policies will tend to tighten as inflation remains high, at the risk of crushing growth that may already be weakened. Fiscal policies, meanwhile, will have to deal with a fresh shock to purchasing power as rate rises push up the cost of borrowing.
We are sticking with a prudent investment strategy. High inflation will encourage further hikes to interest rates. That said, a portion of the upward rate cycle is now behind us, and we are therefore easing our Underweight to sovereign bond markets. At the same time, we are retaining our overall Neutral exposure to equities. We are reducing exposure to emerging markets (equities and sovereign bonds) in light of the sharper slowdown in China's economy. We are also trimming exposure to Japanese equities following the yen's slide, which may have further to go. Lastly, we are maintaining our Overweight to Hedge funds and gold, both still attractive alternatives in uncertain times.