June 27th, 2022

Investing in a decelerating economy

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The global economy is slowing down and much of this is priced in, but the economic outlook remains uncertain. Analysts are predicting everything between soft landings and recessions. Such a world of dislocated markets and high uncertainty offers tactical and strategic advantages, particularly for secular forces like ESG.

1. Economic outlook

As the global economy slows and central banks tighten monetary policy, inflation should start slowly ebbing away. Nonetheless, there are some factors on the supply side that might keep inflation under pressure. These include, among others, current supply chain constraints, persistent or reemergence of Covid-19 lockdowns, slowdown in the real estate market and Russian retaliations (natural gas embargo, with supply already slowing).

The European economy is experiencing the negative effects of very elevated inflation on consumption and sentiment — it is doubtful that growth will slow only to 2.6% this year and 2% next year as consensus expects. Energy prices might still spike higher due to limited supply but as the global economy slows, prices should eventually stabilize at lower levels bringing some relief. For example, supply chain pressures currently seen in North German ports should ease over time bringing relief. Consequently, corporate earnings growth is more likely to disappoint from subdued levels, while investors learn to be more patient and focus ever more on a moderate long-term path for growth.

The US economy should start decelerating as personal savings dwindle and borrowing increases from credit cards to home equity lines, even as the Fed slows the economy. On the other hand, inflation should start to ebb lower helping real income and consumption. While it is hard to predict inflation and growth in a red hot labor market, due to nonlinearities and a lack of historical examples, we sit between different economic scenarios going from decent growth to stagflation or a recession in 2023 leading to volatility in the equity market.

China’s economy is rapidly slowing down on the back of a Covid-19 related policy and a real estate crisis. While the impact of lockdowns should dissipate and measures help, the impact of the real estate market on an economy highly leveraged on it suggests difficult times are still ahead.

2. Markets outlook

Large Tech companies tend to price in a long-term economic growth and innovation that is currently challenged . In contrast, Value combined with Quality, is far more realistic (e.g. Coca-Cola, Air Liquide). Chinese Tech is interesting especially under pressure of climate change as the country is the main producer in many parts of Green Tech. As fear recedes of a rapid global economic slowdown, we sense opportunity amid dislocations in some tech/disruption stocks.

What does it mean?

In such a complex world with dislocations and elevated economic risks, flexible solutions with their multiple risk premia should help. Listed infrastructure and real estate should continue to help hedging against inflation as well as the defensive characteristics and alpha capabilities of covered bonds strategies. Such a complex environment is a reminder of the secular value of ESG.

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Investing in a decelerating economy

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