Global Insights

Market review by Philip Saunders

Market liquidity is fast receding as central banks grapple with inflation for the first time in decades. War in Ukraine is compounding difficulties but accommodative policy in China will prove supportive. The challenging backdrop means investors must be increasingly selective, but some longer-term adjustments will provide compelling opportunities.

17 Jun 2022

3 minutes

Philip Saunders

The fast view

‘Canaries in the coal mine’

  • Much of the current investment narrative concentrates on the topics of weaker markets, rampant inflation and a tougher US Federal Reserve (Fed). In contrast, we think investors should focus on adjustments to levels of liquidity.
  • There have been a series of financial ‘canaries’, or warning signs, flagging the dangers of excess liquidity for some time. These include price corrections for some previously high-flying exchange-traded funds, cryptocurrencies, special purpose acquisition companies and so-called ‘unicorns’1.
  • China’s decision to begin aggressively tightening policy in early 2021 to cool an overheated real estate market was a significant moment. The resultant liquidity squeeze led to a slump for bond prices in this sector. Tougher regulation also contributed to a correction for highly valued domestic technology stocks.

Adding fuel to the fire

  • How much is already in the price? Market valuations have corrected quite substantially but we remain in an uncertain environment. The war in Ukraine has added fuel to the fire and compounded difficulties for central banks by both increasing inflationary pressure and weighing on growth. More broadly, higher commodity prices will have severe ramifications across the developing world.
  • Central banks have not had to make the trade-off between growth and inflation in decades. Their priority now will be dampening inflation, with economic growth concerns taking a back seat for now. This suggests that it is not policy but business cycles that are key. There is a lot of debt outstanding and refinancing it will be tough as central bankers seek to make their inflation policies credible. Companies and economies are in a much tougher environment.

A bipolar economy

  • While real interest rates are too low, acceptable levels of US growth and low unemployment suggest we are in a bipolar economy – the real economy and a financial one. Such a market set-up is inherently unstable and will be difficult to navigate.
  • It is not all gloomy. Historically, credit cycles in China and the US were in sync, but China is now loosening its monetary policy, in contrast with other key economies. This should provide some stability.

Thinking about the next cycle

  • We think the Fed will need to continue tightening more than the market is currently discounting, presenting challenges for developed market equities and bonds.
  • China’s actions in easing interest rates and stimulating its economy should provide support for its domestic equities.
  • Monetary policy divergence will be supportive for the US dollar.
  • Value stocks may be vulnerable to economic growth concerns and so more defensive equity sectors are looking relatively attractive.
  • Gold is one of the few ‘tail risk’ hedges should the war in Ukraine escalate.
  • An accelerating energy transition should provide support for key suppliers and benefit resource stocks.

1 Start-up companies with a minimum value of US$1 billion.

All investments carry the risk of capital loss

Authored by

Philip Saunders
Director Investment Institute

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