What should investors buy as the Federal Reserve (Fed) fights inflation? The manager Allianz Global Investors, one of the most important in the world, offers us some interesting clues to adapt to the new rate hike scenario proposed this Wednesday by the United States central bank.
In his opinion, the market has already discounted that the Fed will raise rates several times in 2022 and will start to reduce its balance sheet to contain prices, which explains the bullish reaction on Wall Street after the Fed meeting.
The evolution of the situation in Ukraine is more important for investors’ short-term risk appetite. The longer it takes to find a negotiated solution, the more uncertainty will persist around possible impacts on global inflation through supply chain disruptions and rising energy and agriculture prices, Allianz said.
“This also explains why we continue to have a tactical preference for US and UK stocks over eurozone stocks, despite more attractive valuation levels for the latter,” they say.
In his opinion, “investors will continue to favor the US market” because it is relatively “safer” in dollars; and the UK market, with greater exposure to commodities, while the euro zone’s growth and inflation outlook is more negatively affected by higher energy prices.
BE CAREFUL WITH THE BOND MARKET
In general, a moderately higher inflation environment tends to favor stocks over bonds, despite the fact that inflation rates above 5%-6% historically penalize the stock market, Allianz explains.
“The bond market will remain under pressure, as it exhibits some unattractive risk premiums, along with outflows that indicate investors are beginning to question its diversification characteristics,” their experts say.
As the Fed raises interest rates and, at the same time, adopts quantitative tightening, they expect a further rise in the long part of the US yield curve. Yields in the eurozone are expected to rise, especially once the situation in Ukraine improves, as the European Central Bank is sticking strictly to its key target of keeping inflation below 2%.
PRIORITIZE VALUE
“From a style perspective, the quality value should continue to outpace growth.” Historically, the stock has outperformed in environments of rising inflation, while the real valuation differential heavily favors value overgrowth, these strategists say.
Inequities, its multi-asset think tank maintains a short-term “negative neutral” view, expecting markets to move sideways with downside risk. Therefore, they would avoid “buying the dips” for the time being and instead become much more active in relative terms.
Over the medium term, they indicate that markets have typically taken past rate hike cycles in stride. But there have been exceptions, including extended periods where investors weren’t rewarded for taking market exposure (beta). Therefore, they continue to see risks of another similar period with widespread disappointing asset returns explained by several reasons:
– A low starting point for nominal/real interest rates and moderate risk premiums across various asset classes.
– Trend towards slower growth, which increases the risks of stagflation in the medium term.
– The current geopolitical volatility causes underestimated and far-reaching repercussions in the economic and financial markets.
The good news is that while the absolute return environment is challenging, there will be an increasing number of relative return opportunities for active investors. Agility will be key in this environment.
