Slow(er) and steady wins the race

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Willem Sels, Global Chief Investment Officer, Private Banking and Wealth Management at HSBC writes that after the rollercoaster of the last 18 months, it is clear from recent data that global economic momentum is starting to slow. 

To some extent this is natural: after the V-shaped recession and quick rebound, sequential growth numbers are bound to slow and enter the mid-cycle stage. However, investors need not fear – slow does not necessarily mean stalling. However, in this environment, building resilient, diverse portfolios is more important than ever.   

Clearly several headwinds exist and the environment we’re facing is plainly more than the natural end to the ‘V’-shaped recovery. Supply disruptions are taking longer to be resolved than many expected, weighing on manufacturing activity, and fears of further lockdowns and rising infection rates are still holding back consumer demand. 

Certainly, these challenges may delay the recovery and cause volatility to increase but they should not derail it entirely. Inventories will still need to be rebuilt, and if it happens at a slower pace, the boost should be smaller but more protracted, keeping the economic recovery going. While it might take some time, consumers will want to spend some of their accumulated savings in coming months, and governments are helping to extend the economic cycle through huge infrastructure and green energy investments, most notably the American Jobs Plan and the EU’s Next Generation Fund. Further, in China, the government’s policy is quite clearly focused on continuity, stability and sustainability of growth.

Therefore, around the world, we think we’re entering a period of slightly lower, but gradual and prolonged growth.

Of course, with slower economic growth, there is the increased likelihood that monetary policy normalisation will also be more gradual, as the risk of overheating is reduced. We expect the tapering of US bond purchases to start in November or December and be a slow process. Further, with employment levels still well above normal and the latest figures showing weaker than expected growth in the labour market, the Fed has repeatedly signalled that it’s much too early to consider rate hikes. Our expectation is that US interest rates won’t move until 2023. The UK may lift rates by 0.4 per cent in 2022 (to 0.5 per cent), and a few emerging markets may start hiking before then, but overall, global financial conditions will likely remain very accommodative. 

For markets and investors, this combination of continued steady growth with low rates forms part of an encouraging backdrop. It’s true that economists may no longer be upgrading their growth forecasts, but equity analysts are. The latest earnings season was strong, with a near-record number of companies exceeding expectations, especially those that adapt to new areas of demand in the post-COVID era and were able to charge through any price increases.  

And with somewhat lower price-to-earnings ratios, investors are likely to be more comfortable with current high valuations. Bond investors are challenged by high valuations as well, but given the very slow nature of policy normalisation, those valuations should be well supported.

While the current environment remains attractive, it is also essential to acknowledge that expected future returns will be slower, given the sharp run-up we’ve seen in recent years. With slowing upside for stocks, combined with somewhat higher volatility, and the ever-present Fed-policy execution risk, building resiliency into portfolios is crucial, rather than overreacting by dialling up risk or rushing to cash. We do this by focusing on quality stocks, large caps and dividend strategies. Constructing diverse portfolios by investing across asset classes, geographies and alternatives should help win the marathon.

 

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