Paul French, Senior Client Advisor at UBS Global Wealth Management in Jersey, shares UBS’s view of potential scenarios that will drive the market in the second half of 2022
Equity and bond markets are driven by stories, hopes and fears about the future path of growth and inflation.
The story of the first half of 2022 has been one of ‘stagflation’, with fears that the Federal Reserve (the Fed) will need to hike rates faster and further to contain inflation-driving bond yields higher and equities lower.
The question now is what story will drive the market over the second half of the year: ‘stagflation’, ‘reflation’, ‘soft landing’ or ‘slump’? And how will markets react?
Now that Fed officials have indicated how closely they are watching and reacting to monthly CPI prints, each inflation data point will likely cause volatility.
Yet it will take several months of data, at a minimum, for the market to gain some clarity on what narrative will dominate the second half of 2022. Investors should be prepared for that volatility as it presents both risk and opportunity.
Volatility is high and it can feel overwhelming for many investors. Here are four simple scenarios that describe the potential outcomes for markets by year-end, along with how investors should position themselves.
1. Stagflation – equities and bonds fall again
S&P 500: 3,100
US 10-year yield: 4%
Probability: 10%
Fears that the Fed remains ‘behind the curve’ on inflation continue to dominate markets and bond yields rise. Higher bond yields make equities less attractive, and stocks fall.
How to invest
• Manage a liquidity strategy: We recommend a liquidity portfolio that meets around three to five years of cash flow needs, consisting of a combination of cash, bonds and structured investments.
• Diversify with hedge funds: In times of high equity bond market correlations, hedge funds can help to diversify portfolios. Some hedge fund strategies – especially macro strategies – are designed to perform well in recessionary scenarios.
2. Soft landing – modest equity recovery
S&P 500: 3,900
US 10-year yield: 3.25%
Probability: 40%
Inflation stays elevated, but investors gain confidence that it is falling under control, and bond yields do not move significantly higher. Corporate profit expectations project neither significant growth nor decline. Stocks rally modestly.
How to invest
• Invest in value: Value stocks tend to outperform while inflation is above 3%. Evidence that corporate earnings can remain resilient would be particularly supportive of energy. We also like broad value with a quality tilt in the UK.
• Position for the era of security: As the war in Ukraine continues, governments and businesses alike are adapting to the new era of security – in terms of energy, cyber and food. Over the longer term, we think this will spur demand for carbon-zero, cybersecurity and agricultural yield solutions.
3. Slump – equities fall but bonds rise
S&P 500: 3,300
US 10-year yield: 1.5%
Probability: 40%
A significant drop in economic demand means growth and inflation fall sharply and investors start to expect a significant drop in corporate profits, hurting equity markets. The Fed considers interest rate cuts, supporting bonds.
How to invest
• Add defensives and quality: Investors can improve the resilience of equity portfolios by investing in quality income and defensive sectors like healthcare. We also recommend closing the gap in fixed income allocations with resilient credit. We also now prefer high-grade bonds.
• Make use of volatility: Capital-protected strategies may allow investors to use volatility to work in their favour and mitigate potential downside risks in case of a downturn in equity markets. Elevated volatility also presents opportunities to generate yield in FX, commodity and equity markets.
4. Reflation – Strong equity rally
S&P 500: 4,500
US 10-year yield: 2.75%
Probability: 10%
Inflation surprises to the downside, and a combination of a ceasefire in Ukraine, an end to zero-Covid policies in China and higher labour force participation, drive much investor risk appetite. Stocks rally sharply.
How to invest
• Be selective in longer-term growth: An alleviation of market concerns about inflation could trigger a rally in growth stocks. We see opportunity for the long-term in growth stocks trading below long-term average valuations, in automation and robotics and in China.
• Invest in private markets: Investing in private equity following public market declines has historically been associated with strong returns. The average annual return on global growth buyout funds launched a year after a peak in the MSCI All Country World Index has been 18.6%, according to Cambridge Associates’ data since 1995.
To learn more or find out how UBS Global Wealth Management can help you reach your goals, visit www.ubs.com or contact Paul French at UBS in Jersey.
Further information
Paul French, Senior Client Advisor, UBS AG, Jersey Branch
1, IFC, St Helier, Jersey JE2 3BX
Tel: 01534 701140
Email: paul.french@ubs.com
UBS AG, Jersey Branch is authorised and regulated by the Jersey Financial Services Commission for the conduct of banking, funds and investment business. © UBS 2022. All rights reserved.
• This advertising feature was first published in Businesslife's Funds Edition in August 2022