OvalX Monthly Macro – June 2022
In this blog post, we will give a quick overview of the global macro outlook to highlight the major themes dominating market sentiment and which could, as a result, impact on market moves for the month ahead.
These are the three main themes dominating sentiment right now. After decades of keeping inflation largely under control, central banks across the globe are now urgently moving to get inflation back in check as rates in the US, UK and most of Europe have risen to levels not seen for more than 40 years.
Since the 1970s, central banks have been able to keep their interest rates low as inflation seemed to have been tamed. This situation has changed. The response to the pandemic was a record amount of liquidity provided by central banks globally. This coincided with many manufacturing plants shutting down because of pandemic lockdowns. This resulted in more liquidity chasing fewer resources, which only has one outcome: higher prices. Then the perfect storm continued as the war in Ukraine pushed energy prices higher.
So, the low-to-zero interest rate environment we had become accustomed to is now a thing of the past, as central banks are being forced to push interest rates higher. This is a major concern as equities have become accustomed to this low interest rate environment.
The global economy over the past 30 years has adapted to operate within a broadly interest-free rate environment, certainly once inflation is considered and real interest rates are used.
So, how will equity markets fare as interest rates increasingly normalize?
Can growth stocks, for example, continue with the historically high valuations?
Also, as central banks become increasingly hawkish on rates, the concerns mount that their attempt to ease asset prices could lead to a hard landing, and maybe even recession. These fears naturally will have an impact on corporate earnings expectations.
So far, expectations for earnings in H2 have not been walked significantly lower. This means if we do see a worsening picture there could yet be further downside on equity indices.
Morgan Stanley for example has stated recently that only a mild recession is currently being priced in, and that a worsening picture could see the US 500 trading down around 3,000 by the year end, against 3,800 currently. These current levels of 3,800 are already around 20 percent off the recent highs, suggesting some major headwinds for the markets to navigate in the months ahead.
-How much additional clarity will we get on these factors in July?
-Is the US500 on track to trade at $3,000 by year end?
-Can the central banks contain inflation?
-Just how many rate hikes are incoming?
-How will equity markets fare in this new environment?
-How many zombie companies will be uncovered?
-Is a recession coming and, if so, how bad will it be?
It is unlikely any of those questions will be fully resolved in the next few weeks. However, every piece of data that adds to the weight of these arguments could be the catalyst for quite significant and sharp market moves. In addition, sentiment is not helped when Facebook parent Meta Platforms recently warned its employees to expect one of the “worst downturns that we’ve seen in recent history”.
It would appear wise then for investors to hope for the best but be prepared for the worst.