In light of recent financial market volatility, we have prepared a brief commentary piece to share our perspective.
Calendar year 2021 was a generally positive one for financial markets and risk assets—but thus far in 2022 bond yields and volatility spiked higher while equities declined. Recent weakness has coincided with investors’ concerns about central bank policy around interest rates and inflation, continued Covid-related economic disruptions, and geopolitical tensions over Russia.
Acknowledging a good bit of uncertainty, our base case assumes a continued global economic recovery transitioning to a more moderate, but still above-trend, pace. Growth and policy support may have peaked for this cycle—but the likelihood of an imminent US or global economic recession appears low, given the strength of consumer balance sheets. Without a recession, history suggests a severe equity bear market is unlikely. However, uncertainty about the inflation and monetary policy outlook remain key risks.
The economic backdrop should remain supportive of corporate earnings and, therefore, risk assets. Yet, equity valuations remain above their historical averages and are most elevated in the US. Therefore, our outlook assumes some multiple compression, or a decline in price/earnings (P/E) multiples, over the next few years—which seems appropriate given the expectation of rising interest rates and high policy uncertainty.
In terms of portfolio strategy, we believe proper diversification is as important as ever. Recent market volatility may create attractive investment opportunities, which we’ll continue to evaluate. However, at this point, our tactical portfolio positioning themes remain largely unchanged. We continue to target an underweight position to core/investment grade fixed income given historically low yields. Within equities, we remain underweight to US stocks given stretched valuations but fully invested in more reasonably priced international and emerging markets stocks. We are targeting an overweight position to “real assets” like commodities and energy-related stocks given the risk of stickier inflation and attractive valuations.