Insights

Weekly Market and Portfolio Update

Geraldine Sundstrom, portfolio manager, comments on what’s moving markets and how the PIMCO GIS Dynamic Multi-Asset Fund (DMAF) is positioned.

FOREWORD

  • Access these views via the Dynamic Multi-Asset Fund, a dynamic fund designed to deliver across market environments and help investors navigate the toughest market situations.


From the desk of Geraldine Sundstrom, Friday 21st January 2022.

From Rotation to Recession!?

It was a wild week in the market with risk assets exhibiting steep losses, but also incredible intraday volatility. For sure, a wind of anxiety is blowing, and it is certainly unusual to start a year with the S&P 500 already down almost 8% just three weeks in. Looking at the Nasdaq, more than 70% of its constituents are in bear markets with half down over 40%.

In such moments of volatility and uncertainty, it is important to keep our eyes on the horizon and assess the true extent of the situation and potential damage. While volatility is always unpleasant, it might be true risk but it may also represent an opportunity.

Since the start of the year, markets have grown increasingly worried about the inflation situation. To add fuel to the fire, quite literally, geopolitical tensions combined with healthy demand have pushed oil prices materially higher, and Brent reached $88 per barrel during the week. Many fear that inflation could be self-sustaining or out of control and will require a very aggressive move by the U.S. Federal Reserve. Indeed, many forecasters or market participants are moving the expected numbers of rate hikes from 3 to 4 to 5, with some even calling for moves in 50 basis point (bp) increments. At first, the spectre of higher rates buoyed part of the market and encouraged rotation out of so-called growth stocks into value stocks, like financials and energy companies. But the mood quickly turned to the risk of the Fed having to outright kill growth to get inflation under control, so every part of the market eventually succumbed. In particular, banks’ earnings reports results, which come early in the season, highlighted that they aren't immune to cost inflation and that loan growth is unlikely to lift at all in a rising interest rate environment. This resulted in the KBW Bank index giving up its entire 11% year-to-date (ytd) gain in a week.

In the past few weeks, we have tried to highlight that inflation could be a rearview mirror story and that when properly looking around there are signs that the situation will improve in 2022, making a drastic and damaging move by the Fed less likely.

There is indeed a long list of factors that will get in motion to help the situation on the inflation front in 2022:

  1. Fiscal retrenchment: The fiscal impulse globally is diminishing very fast and in the U.S. it is expected to be 6% of GDP lower versus 2021. Stimulus payments to U.S. households will reduce to $660 billion from a whopping $2.8 trillion in 2021, while the savings rate has already come off quite a bit.
  2. Consumer sentiment is falling: A direct consequence of the above is that consumer confidence has been markedly dropping. As such, breakneck consumption is likely to slow significantly, all the more so given that income has been seriously eroded by inflation in real terms. Further, dramatic energy price increases in Europe particularly are going to eat away at household income as energy will on average cost 54% more in 2022 versus 2021.
  3. Demand destruction: Higher prices are a natural phenomenon to clear supply versus demand and certainly the high inflation we are experiencing will result eventually in lower demand.
  4. Better operating environment: Companies will face a much more friendly operating environment in 2022 as bottlenecks start to reduce gradually. Further, even if delays remain considerable and Omicron provides one more wave of disruption and contingencies, orders were placed a year ago and on an ongoing basis, so companies are less likely to be at a complete standstill as old orders start to arrive soon. There are also hopes that labour participation will improve somewhat as the pandemic hopefully ends and life returns to a more normal state of play.
  5. Synchronised global monetary tightening is underway: In 2021, central banks probably missed the global perspective and the cumulative impact of every country in the world conducting combined monetary and fiscal stimulus against a constrained world backdrop. This time we have a vast number of central banks all hiking at the same time (China is a notable exception), which will conspire to reduce demand everything else being equal.
  6. Base effects: These will be more prominent in the second half of the year but a number of key inflation inputs will most probably not repeat the same performance two years in a row.
  7. Medium term: Every problem eventually comes with a solution…the impact will only show up from 2023 onwards but tight labour markets are fueling demand for robotics, while high gas prices and geopolitical tensions will accelerate the moves towards much cheaper renewable energies. Frans Timmermans, the European Union’s climate chief was pretty blunt in his speech during the week : “if you really want to make sure that you can provide stable, affordable energy to your citizens, renewables is the answer” and we shall spare here the non-subtle geopolitical reference he made.

For all the above reasons, we are feeling more confident about inflation in 2022 versus 2021, and the base case is certainly that markets are likely overreacting at this juncture. It was always the case that inflation was going to look awful in the first few months of 2022 and importantly that growth would slow down substantially as the reopening boom ebbs. PIMCO has had these forecasts for months now and not much new has happened in the last few weeks except fear itself. The logic of a mid-cycle economic point seems pretty anchored, which argues for a rotation towards higher quality and affordable growth, while positioning for recession still seems premature.

In the DMAF portfolio, the main move was to continue increasing emerging market FX carry where valuations exhibit rare levels of discount, together with aggressive central banks restoring real interest rate differentials. At the height of the hike fears, we also dipped in a toe and for the first time in a very long while bought some U.S. duration via the 5-year sector.

Géraldine 

How can DMAF benefit investors in today’s uncertain markets?

i. Provide optionality
ii. Enhance returns
iii. Control risk

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Autor

Geraldine Sundstrom

Head of Asset Allocation EMEA

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Data as of 21st January 2022 unless otherwise stated. 

Past performance is not a guarantee or reliable indicator of future results and no guarantee is being made that similar returns will be achieved in the future.

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