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Manulife InvestChoice – 2022 Q2 Market Outlook

April 2022

Quarterly Macro Outlook

Just as we were looking to a return to some semblance of postpandemic normalcy, the Ukraine conflict and resulting geopolitical stress have further complicated the macro landscape for 2022.

 

As we’ve mentioned previously, the extended disruption to global supply chains and surge in commodity prices have amplified the dilemma facing major central banks: On the one hand, this will push headline inflation (and inflation expectations) even higher; on the other hand, it will amplify the squeeze on real incomes, economic activity, and core inflation further ahead. Tightening in this environment risks exacerbating the downside risks to economic growth. In our view, there’s very little monetary policy in isolation can do to address cost-push inflation.

 

The best-performing markets year to date are energy (41.3%)1, agriculture (25.0%)1, and industrial metals (21.5%)1, reflecting the worsening global shortage after removing the supply from a critical producer such as Russia. By extension, equity markets leveraged to rising commodity prices, such as Indonesia, Canada, Australia, and Brazil, have outperformed. Precious metals, the U.S. dollar (USD), Chinese government bonds, and U.S. Treasury bills have also performed well relative to the weakness seen in other assets, reflecting their safe haven status.

 

At the other end of the spectrum, growth-oriented stocks and sectors that have a higher equity duration—Chinese equities; stock markets in the Europe, Middle East, and Africa regions—and Asia high-yield debt have underperformed, reflecting these markets’ sensitivity to tighter global financial conditions and their respective trade, financial, and geopolitical linkages to the Ukraine crisis.

 

Cross-asset volatility remains elevated: Our composite measure of risk aversion indicates a difficult quarter ahead for risk assets, yet many central banks are pushing ahead with monetary policy normalization. Apart from the questionable efficacy of tightening into a negative global supply shock, this dynamic has important implications for global liquidity.

 

Global liquidity growth has slowed markedly—from a record 21.5% in March 2021 to 5.4% by mid-March 2022, the slowest rate since April 2020.2 A declining global liquidity impulse is most relevant to emerging- market (EM) growth and earnings, but it also has broader relevance to risk assets.

 

We’re still of the view that policymakers’ concerns over high inflation will ultimately give way to worries about slower growth. For this reason, we anticipate a dovish pivot from the U.S. Federal Reserve (Fed), likely in Q3, and believe the U.S. central bank’s tightening cycle will fall short of the market’s pricing in terms of its pace, magnitude, and duration.

 

Crucially, we think it’s extremely likely that the next global stimulus phase will represent a significant departure from the playbook that investors have been conditioned to seeing since the global financial crisis. While the public policy response to every crisis in the past 15 years has been steeped in neoliberalism—broadly characterized by globalization, offshoring and free trade, limited role for the state in the economy, a structurally lower consumption share of GDP, and the hyperfinancialization of the global economy—the social and political appetite to repeat these policy prescriptions is incredibly limited at this juncture. Indeed, we’re already seeing revolutionary shifts in the opposite direction.

 

Europe has awakened to the great power competition and, in a historic shift, Germany has announced plans to ramp up its defense spending and end its reliance on Russian energy in light of the crisis in Ukraine. Significant increases to defense spending are being adopted by governments across the world. Meanwhile, Western solidarity around sanctions has been ramped up to previously unthinkable levels—key Russian banks have been barred from the global SWIFT system and major economies have introduced restrictive measures that will prevent the Central Bank of Russia from accessing its foreign reserves. Many Western banks and businesses are engaging in self-sanctioning, opting to avoid unsanctioned Russian entities out of fear that the official sanctions list might broaden at a later time.

 

These are profound changes, developments that have significantly accelerated the pace at which we’re progressing toward an even more fragmented global economy. In fairness, this movement was already in place before the pandemic but has been catalyzed by Russia’s invasion of Ukraine. Military conflicts change everything. As the politics change, economics will too, and financial markets—as history informs us—will follow.

 

From a longer-term perspective, we continue to expect to gravitate toward a medium- to longer-term macro landscape in which governments will play even bigger roles in economies. Naturally, the extent of government involvement will vary greatly from economy to economy, and central banks are likely to come under increasing pressure to monetize government spending.

 

Against that backdrop, key macro themes going forward will, in our view, include significant geopolitical upheaval, private sector deleveraging, reshoring and reindustrialization in developed markets/industrialization in EM, lower and flatter yield curves, increasingly negative real interest rates, competitive currency devaluations, more government regulation, and increasing protectionism/localization.

 

The strategic investment implications from this macro thesis remain a portfolio biased toward up-in-quality assets, U.S. equities and fixed income over other developed markets, and EM with less room or willingness to monetize deficits (e.g., the eurozone and China). Similarly, the thesis would favor the USD over high beta fiat currency. Sectorwise, critical industries benefiting from industrialization and rising living standards in both the United States and rest of the world should outperform; these include utilities, materials, and consumer staples.

 

Finally, exposure to alternative assets (e.g., gold, residential real estate investment trusts, and crypto assets) as a form of protection from fiat devaluation may also make sense.

US: Aggravated and extended inflationary pressure weaken the confidence on economic growth 

While the United States may be geographically removed from the Russia- Ukraine conflict, it won’t be unscathed by the spillovers. Spiking commodity prices will only aggravate and extend the inflationary pressure that was expected to recede during the second quarter.

 

Meanwhile, weaker confidence and supply chain disruptions should weigh on economic growth. Against this potentially stagflationary backdrop, the Fed is in the unenviable position of feeling compelled to tighten monetary policy despite questions surrounding the efficacy of such a move on stemming supply-side inflationary shocks, not to mention its potentially negative impact on growth. While business investment should remain healthy, the consumer outlook is much more delicate. Since consumer spending had been brought forward during the pandemic and confidence is flagging amid higher interest rates and market volatility, housing activity and discretionary spending could soften going forward. Employment, however, is likely to remain firm, which may provide some offset.

Asia: Spike in the prices of key strategic resource commodities, uneven impact across the region 

As a net food, materials, and energy importer, the Asia-Pacific region is vulnerable to the reduced supply—and spike—in the prices of these key strategic resource commodities owing to the conflict in Ukraine.

 

However, we stress that the region isn’t monolithic, and the impact across the region will be uneven. There are also larger spillover effects to consider: the potential for higher inflation and inflation expectations, whether an economy can rely on strong export growth to materially offset rising food and energy import prices and/or the policy space to withstand further deterioration in its fiscal position, and a potential liquidity/credit shock. When we screen for economies that are least vulnerable to these potential shocks, we find that Singapore, Malaysia, Australia, and New Zealand (NZ) are likely to be the biggest beneficiaries from rising prices. Meanwhile, Indonesia, the Philippines, NZ, and India appear least exposed to a potential liquidity shock. Balancing the simultaneous impact from these two shocks, our analysis suggests NZ, Malaysia, Indonesia, Australia, and Vietnam will be the relative macro outperformers among the economies that we follow.

Europe: Likely delay in the ECB's policy normalization, increased flexibility on timing of rate hikes werses tapering

The significant increase in energy prices on the back of the conflict in Ukraine is delivering a crippling blow to the euro area’s economic growth outlook. The market has reduced the pricing of near-term rate hikes despite record high inflation that’s likely to continue through—at least— several quarters to come. The region’s terms of trade have weakened significantly, and the outlook for consumption is deteriorating as higher energy costs erode discretionary income. Efforts by the region’s governments to mitigate consumer burdens will carry fiscal consequences; however, these are likely to pale in comparison to plans for historic, collective investments across defense and energy. The European Central Bank’s (ECB’s) policy normalization is likely delayed, but not completely abandoned, and we see scope for greater flexibility on the timing of rate hikes versus tapering. Barring surprises, policymakers should find considerable reassurance in plans for new joint debt issuance among EU members as they build on the success of the Recovery Fund.

1 Source: Commodity Research Bureau, Macrobond, Manulife Investment Management, as of March 11, 2022.

2 Bloomberg, as of March 14, 2022.

Disclaimer – Quarterly Macro Outlook

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.

This material was prepared solely for educational and informational purposes and does not constitute a recommendation, professional advice, an offer, solicitation or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. The economic trend analysis expressed in this material does not indicate any future investment performance result.   This material was produced by and the opinions expressed are those of Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. Past performance is not an indication of future results. Investment involves risk, including the loss of principal. In considering any investment, if you are in doubt on the action to be taken, you should consult professional advisers.

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