Bull market to bear: mid-term financial report

We are now halfway through 2022 and the post-COVID bull market has come to an end. We are officially in bear territory.

Our outlook is more difficult than expected at the start of the year due to the Fed’s tightening campaign, the war in Ukraine and the increase in COVID-19 cases in China. This article examines a world in transition and the drivers that will determine the trajectory of the global economy and financial markets.

The campaign against inflation and the end of easy money
The most pressing question for investors revolves around the campaign against inflation by central banks – particularly the Federal Reserve. Inflation in the United States is at its highest in several decades and a tight labor market calls for tighter monetary policy. But the lingering economic impact of the pandemic makes it difficult to decipher how much Fed tightening will be needed. Higher rates and less central bank liquidity – the end of easy money – aim to tighten financial conditions. The question becomes: how much tightening is enough, but not too much?

There is growing evidence of oversupply in the trucking industry and global shipping rates are collapsing. Used car prices have also started to fall. These developments suggest that at least some of the inflation we have seen over the past 18 months was related to COVID-19 and may partially normalize as the pandemic wanes.

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Additionally, the housing market is slowing, with mortgage applications declining. As we enter the second half of the year, we will begin to see more signs that this rate hike cycle is accelerating an economic downturn that was expected to occur naturally as the pandemic-era stimulus receded.

Recession risks have clearly increased. Raising rates enough, but not too much – is a delicate balancing act that has always eluded central banks.

War in Europe and raw material supply shocks
As a general rule, we do not believe that investors should make significant changes to investment portfolios solely based on geopolitical events. History shows that underlying economic forces tend to influence markets more than specific geopolitical events. However, where there is a direct link between the event and the global economy, we should be aware of the potential impacts it could have on investment portfolios. In the case of Russia’s invasion of Ukraine, the link – energy – is clear.

Europe’s dependence on Russian energy will be felt globally, but most intensely on the continent itself. Economic momentum is already slowing and the risk of a Russian energy embargo is high compared to pre-war levels.

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Global benchmarks for crude oil are trading near decade highs, and U.S. retail gasoline prices recently hit record highs before retreating in the past month. Investors are increasingly concerned that volatility in energy and agricultural commodities could lead to turbulence and destroy demand as consumers forego other spending to ensure access to basic necessities.

China’s handling of COVID-19 and the resulting global fallout
In China, COVID-19-related lockdowns have reduced consumer activity and production of goods critical to global supply chains. Policymakers appear committed to Zero-COVID policies which increase risks to global growth prospects.

The lockdowns exacerbate China’s economic weakness and pose a risk to global supply chains that are still under strain. Current lockdowns are easing locally. But limited acquired immunity means future waves and shutdowns of COVID-19 are likely, effectively making it impossible for consumers to generate any kind of above-trend economic growth.

Final Thoughts
With these factors in mind, investors can consider different approaches to staying invested and strengthening their portfolios.

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1. Use core fixed income as portfolio weight
Due to the low interest rates of the past two years, bonds offered neither additional yield nor useful portfolio protection. As rates have started to rise, investors are finally receiving adequate return and portfolio protection in the event of a recession.

2. Prioritize balance and quality in equity portfolios
We expect trend-line earnings growth throughout the year. Across a variety of sectors, we see opportunities with high-quality companies that offer stability and earnings visibility. Health care, industrials and technology are our three favorite equity sectors.

3. Positioning for structural change
The next cycle will likely feature redesigned and restructured global supply chains, with manufacturers bringing their factories back to earth (or closer to earth) and making them more self-sufficient for greater efficiency. We also expect significant progress in the energy transition as well as a transformed real estate sector. Investors will have a wide range of opportunities that they can align with their financial (and non-financial) goals and values ​​in these sectors.

Yet we do not underestimate the challenges of the markets of the global economy in transition. We also don’t underestimate the potential opportunities ahead. After all, investing throughout the cycle means investing for the next cycle.

David Nolet is Managing Director and Fort Worth, TX Market Director at JP Morgan Private Bank. David oversees a team of bankers, investors, wealth strategists and financial specialists who provide advice on investing, philanthropy, family office management, credit, fiduciary services, advisory services and more . To learn more about David Nolet and the Private Bank in Texas, visit our website.
This article is sponsored content from JP Morgan Private Bank.

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