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LGT Beacon: Torn between two paths for the global economy

July 22, 2022

Markets seem torn between two future paths. On the one hand, we have lingering concerns of an overheating economy on the back of an ongoing demand rebound and supply squeezes – an inflationary confluence that keeps central banks rushing toward a restrictive policy regime. On the other hand, rising interest rates fuel fears of a sapping economy, with many investors now expecting an imminent recession. We take a balanced path through this challenging environment.

The past few weeks' data highlight the persistence of a challenging market outlook: 

  • The global economy continues to cool but inflation remains hot, with price pressures generally broadening and hence potentially entrenching themselves in more and more sectors of the economy, beyond the pandemic-related areas, energy and food.
  • Central banks are likely to keep tightening monetary conditions by scooping up liquidity and raising interest rates as quickly as possible, leading many investors to turn ever-more bearish on markets.
  • Over the past half year, financial markets have priced in a higher level of interest rates, but no outright recession yet – corporate earnings forecasts thus have room to fall.
  • Europe is on the brink of a recession, as high inflation erodes consumers’ spending power, while the industrial sector may be forced to cut production to cope with a potential energy supply crisis; in addition, Italy – the currency area’s largest debtor – seems to be headed for early elections, risking political uncertainty at a critical time (European Central Bank rate hikes, policy transmission risks).
  • Geopolitical conflicts and China’s broader domestic policy choices add a meaningful degree of extra uncertainty.

Mitigating factors and counter-cyclical opportunities

At the same time, there are some mitigating factors of a counter-cyclical, if not counter-intuitive, nature: 

  • Commodity prices have fallen significantly from their year-to-date highs in recent weeks. Energy is down about 25%, and many industrial metals and food-related commodities have dropped even more. While these declines reflect concerns about China's elusive recovery and a possible recession in the West, they do take the edge off the inflation problem. Consumer goods' prices may thus soon start to soften, which would in turn confirm expectations that inflation has peaked somewhere around current levels.
  • Investors' sentiment surveys and positioning data are very bearish and many indicators are consistent with levels that have historically been followed by relief rallies – sometimes even trend reversals. For instance, the latest institutional survey by Bank of America Merrill Lynch shows that growth optimism is now the lowest on record, as is the share of institutional asset allocators that are overweight equities (with data going back to 2008). 

To read the full report, click on the link: LGT Beacon

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Note: The next edition of the LGT Beacon is scheduled for August 2022.