Second Half Equity Strategy

Feature Stories | Jul 13 2022

Various institutions provide their outlooks for inflation, monetary policy and commodity prices and offer portfolio recommendations to counter current risks.

-Recession or no recession?
-How to protect against stagflation
-Local equity preferences
-A wider view of global risks


By Greg Peel

JPMorgan’s global research team rather understatedly notes the first half of 2022 has been “difficult for investors”. While a fall to date for the S&P500 of -20% is seen as “modest” compared with -35% in the 2020 covid crash and -50% in the GFC, the reality is a “typical cross-asset portfolio”, implying a mix of stocks, bonds and cash, has declined more than any other downturn since the GFC given a simultaneous decline in stock and bond prices.

The major driver has been a sudden shift from the Fed to aggressive monetary tightening in order to address inflation which is ironically, as JPMorgan notes, out of the Fed’s control, given it is driven by energy and food inflation, covid-disrupted supply chains and the war.

The most recent step-up in Fed aggression has led to markets fearing such action will lead to economic recession. This leaves economists and strategists in a difficult position, JPMorgan suggests, of guessing whether central banks will make another mistake (alluding to the Fed’s failure to respond to inflation and post-covid US economic recovery until the midnight hour) and simply compound the damage produced by years of underinvestment in energy, the impact of covid lockdowns and the war.            

But JPMorgan’s economists do not see a recession materialising in 2022. The probability of recession has certainly increased meaningfully, but the economists see global growth accelerating from 1.3% in the first half of 2022 to 3.1% in the second.

This is linked to a forecast decline in global inflation from a 9.4% annualised rate in the first half to 4.2% in the second, which would allow central banks to pivot and avoid producing a downturn.

This forecast is connected to two critical assumptions.

Firstly, that China’s growth will accelerate to 7.5% (annual) in the second half from as good as zero in the first.

As the first half reflected the impact of widespread lockdowns, JPMorgan’s forecast must thus assume no further lockdowns, despite no change to China’s zero-covid policy.

The second is an assumption the second half will bring progress towards a solution in Ukraine or at least a lasting ceasefire, easing geopolitical fears.

We note that the Soviet war in Afghanistan lasted ten years before the Russians withdrew. Yeltsin’s war on Chechnya last two years, before Putin came back three years later for another eight years, and then withdrew.

The war in Ukraine has been underway for a bit over four months.

On JPMorgan’s assumptions, the economists still believe in the commodity supercycle, and view commodity-related assets, sectors and countries as both a valuable source of returns and a hedge against inflation.

JPMorgan is among many financial institutions who released their second half market strategy reports in June, which reflect a lot of time and effort to produce, so much has transpired in the meantime. JPMorgan is but one house which, drawing upon the history of high-inflation periods, recommend commodities as an inflation hedge.

But are commodities really a hedge against inflation? Commodity prices are inflation – energy, food, fertiliser, metals/minerals… Since the end of June, the falls in commodity prices brought about by recession fears and an assumption of “demand destruction” have only accelerated, and most notably oil prices fell -20% to below US$100/bbl, before recovering slightly.

For JPMorgan’s forecast of 4.2% second half global inflation to prove accurate, it will only be largely because of falling commodity prices, and if inflation numbers begin to turn down meaningfully from this month, central banks may yet ease off the accelerator and recession fears will abate.

The near-term end-point for inflation will still be beholden to the longevity of the war, Chinese lockdowns (or not), lack of spare capacity in oil production and the “stickiness” of wage inflation.

JPMorgan’s view is there will be no recession, but markets are pricing in recession. On that basis risky assets are too cheap. US small cap stocks currently trade near the lowest valuations ever, with many market segments down -60-80%.

“Positioning and sentiment of investors is at multi-decade lows. So it is not that we think that the world and economies are in great shape, but just that an average investor expects an economic disaster, and if that does not materialize risky asset classes could recover most of their losses from the first half. Our bullish and out-of-consensus view is hence a forecast of a lost year, ie a recovery of [first half] losses in risky assets.”

S&P500

Most US investment houses are forecasting the S&P500 to close 2022 above where it is now (3900), albeit having lowered their targets from prior levels.


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