New era likely to be characterized by less liquidity, higher inflation, and higher interest rates; shift favoring value investing going forward could be underway

BALTIMORE, June 15, 2022 /PRNewswire/ — T. Rowe Price, a global investment management firm and a leader in retirement services, has released its midyear market outlook for 2022. It includes insights from three of the firm’s senior investment executives: Arif Husain, CFA, Head of International Fixed Income and Chief Investment Officer

Sébastien Page, CFA, Head of Global Multi-Asset and Chief Investment Officer

Justin Thomson, Head of International Equity and Chief Investment Officer

Key takeaways for the second half of 2022 include: The war in Ukraine, COVID-19 lockdowns in China, and central bank monetary tightening are likely to keep the investing environment difficult.

In the near term, the war will likely continue to impact global commodity markets, keeping food and gas prices high, but over the longer term it could accelerate the shift to renewable energy.

Rising interest rates punished equity valuations in the first half, and rising economic concerns could lead to a slowdown in corporate earnings and put further pressure on stock prices.

U.S. Treasuries and other sovereign bonds didn’t offer many diversification benefits in the first half as correlations with equity returns soared, repeating a pattern seen in recent years.

INFLATION RISKS AND NAVIGATING ECONOMIC HEADWINDS Inflation can trigger a growth shock, given that (1) higher energy and food prices are, in effect, a tax on the consumer, who are the main engine of global economic growth; (2) with interest rates rising, continued earnings gains will be needed to support positive equity returns, but higher wage and input costs could cut into profit margins; and (3) inflation raises the risk that the Fed will hike rates too aggressively, increasing the cost of capital and causing a recession.

Some investors now question whether inflation has already peaked. There have been anecdotal signs in some markets that price pressures are easing – such as a slowdown in home price appreciation and cooling demand for labor – but clearer evidence is needed.

Even if inflation has peaked, many fixed income investors appear unconvinced it will quickly return to the Fed’s long-run target of 2%. The market has already priced in multiple future Fed rate hikes, yet it still expects inflation to overshoot the Fed’s target by a full percentage point per year over the next five years.

A possible silver lining is that there is plenty of potential pent-up supply in the global economy, which could help bring inflation down if supply-chain bottlenecks can be unclogged. The question is whether fixing supply chains could do part of the Fed’s job for it.

RISING INTEREST RATES, EQUITY VALUATIONS, AND EARNINGS Although earnings momentum sagged in many non-U.S. markets in the first half, earnings per share growth in the U.S. remained surprisingly steady. But this strength may not last and U.S. earnings could likely decelerate in the second half, challenged by slowing economic growth.

Supply-chain improvements could also impact earnings – but possibly not positively. While moving more products might boost sales and revenues, it also could limit pricing power and eat into profit margins.

Poor earnings environments historically have tended to favor the growth style of investing over the value style, but this time could be different, given the heavy weight the technology sector now carries in the growth universe.

There have also been some late-cycle economic effects that are detrimental to tech, such as skill shortages and salary inflation, and consumer-oriented technology platforms could be exposed to a cyclical slowdown in spending. These factors also suggest the style rotation has tipped in favor of value.

Chinese equity valuations appeared potentially attractive. The regulatory climate in China, including treatment of the country’s domestic technology platform companies and its tough stance on foreign depository receipt listings, could ease and turn more market friendly in the run up to the Chinese Communist Party’s 20th Party Congress later in the year.

FLEXIBLE FIXED INCOME U.S. Treasuries and other developed sovereign bonds did a poor job of offsetting equity volatility in the first half, suggesting that investors may need to expand their search for diversification across fixed income sectors and geographic regions.

It’s unclear whether the spike in correlations between stocks and bonds seen in early 2022 was temporary or if it can persist. If the latter is true, alternatives to the traditional 60/40 stock/bond allocation that include dynamic hedging and other defensive strategies could offer advantages to some investors. […]


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