2022 Q2 Outlook2022Q2Outlook

Global growth, already slowing amid high inflation, is likely to come under more pressure as Russia’s invasion of Ukraine raises uncertainty.

Executive Summary

Economic Outlook:

• The global economy was already experiencing high levels of uncertainty at the beginning of 2022 amid a growth slowdown, high inflation, a hawkish pivot among central banks, and the ongoing impact of COVID on global supply chains and demand.
• Russia’s invasion of Ukraine, however, ratchets up the level of uncertainty:
  • The US, European Union, and their allies have imposed stiff economic and financial sanctions that have pushed the Russian economy into a tailspin, collapsed the value of the ruble, and raised the prospect of a sovereign default on Russia’s external debt.
  • These actions have exacerbated an existing energy/ commodity price shock that worsens both growth and inflation risks.
• 2022 GDP growth forecasts have been marked down and inflation expectations up since the beginning of the year. These trends could continue depending on the severity, duration, and outcome of the conflict.
• Geographically, Europe is likely to bear the brunt of the fallout from the Russia/Ukraine conflict, including increased recession risk, given its proximity to the war and its significant trade and energy supply linkages to Russia. The US economy should be more insulated by comparison.
• On the flip side, the war is likely to be a growth boon to oil exporters in Latin America and the Middle East given the sharp rise in energy prices.
• Central banks are forced to walk a tightrope, balancing an increasingly dire inflation problem with geopolitical risks to growth.
• The fog of war increases the odds of central bank policy mistakes resulting in recession, but that is still not our base case, and we subjectively assign roughly 30% odds to a global recession over the next 12 months.
• Other scenarios include central banks failing to get inflation under control for a longer period, absent a downturn, and a soft landing—where inflation is brought back down toward 2% and the economy avoids recession.

Market Outlook:

• Global markets started the year in a risk-off mood, with high inflation proving persistent and the US Federal Reserve’s (the Fed) hawkish pivot intensifying. Russia’s invasion of Ukraine made a difficult situation even worse for global central banks by adding a stagflationary shock to the mix.
• Equity markets corrected during the quarter, with some market declines meeting the technical definition of a bear market. Assuming the war with Russia does not extend beyond Ukraine’s borders, we expect equity markets to recover lost ground but calendar-year returns are likely to be weak, though positive, in 2022.
• Moves in bond markets were also substantial, with yields repricing upward given the significant change in central bank policy expectations, particularly for the Fed.
• In an environment of rising interest rates, stocks have experienced notable multiple compression from 2020’s elevated levels. Some markets look very attractively valued (e.g. Latin America and UK), with forward PE ratios significantly below their 10-year averages. The US market, however, still trades at an above-average valuation multiple.
• Rates could move higher from here given growth and inflation dynamics but a lot of damage has been done to start the year. The yield rally may need to consolidate, similar to what we saw last year after a yield spike in Q1, before moving higher again.
• We are bearish on government bonds on a multi-year horizon but we see a better risk-reward profile in fixed income risk assets, where spreads have widened, especially in emerging market debt.
• The structural bull market in commodities remains intact based on supply-demand imbalances that will not be easily remedied in the near term. Russia’s invasion of Ukraine strengthens the commodity bull case by adding both more supply constraints and a demand boost. Commodities remain a stellar hedge against both inflation and a worse-than-expected outcome in the Russia/Ukraine conflict.
• We are overweight commodities and underweight bonds in our multi-asset portfolios. We pulled back to neutral on global equities during the quarter, adding to cash, and we remain neutral on global real estate.