In the Face of Uncertainty, Remain Selective

A few weeks ago, I shared our thinking on a number of macroeconomic, geopolitical, and public health concerns weighing on markets and our Macro and Absolute Return research team’s observations of their potential impact. The team emphasized the intersection of a number of warning signs and how they combine to create an unusually wide range of outcomes that investors must navigate.

The graphic below illustrates some of the key matters weighing on markets.

The impact of each of these issues (and when taken together) are not easily handicapped and will likely persist in the near-to-medium term, making generic long beta plays far riskier in our Macro and Absolute Return research team’s view.?

The Bull Case for Risk Depends on a Race Against Time

For risk-on assets to advance meaningfully higher, the supply chain bottlenecks we are currently experiencing would need to ease before the Federal Reserve (Fed) increases its benchmark interest rate too much—and too quickly. Global economic growth would advance higher, while slowing inflation.

If bottlenecks do not ease, the Fed will have no other choice other than to meaningfully tighten monetary policy by raising the Federal Funds Rate and potentially unwinding its balance sheet. But do those actions really help address the problem weighing on markets?

Tighter monetary policy is meant to cool aggregate demand; it does not fix supply-side issues. The key question, therefore, is whether supply can recover before the Fed goes too far? As previously noted, the current outlook remains mixed.

Certain Parts of the Fixed Income Market May Offer Compelling Relative Value

Our team noted that, for the first time in years, there are investment grade and high yield corporate bonds trading at relatively steep discounts, offering the potential for convexity (which is a security’s non-linear price change with respect to a change in yield) not seen in some time.?

China Should Be Able to Behave Countercyclically

Current conditions in China paint a mixed picture. The country’s policies continue moving in the direction of support, but COVID-19 continues to adversely impact its economy. This dichotomy further muddies the country’s political backdrop.

Our team believes that increasing China’s money supply is key—it is its one policy tool that works, and the team believes that its latest COVID impact should provide policy makers additional reason to pull that lever.

Remaining Selective is Key

Investors are witnessing an unusual time in markets where there will be clear winners and losers. Rising input costs and interest rates will not impact all companies to the same extent—some will adapt successfully, and others will fail. Investors should remain focused on identifying those companies with true pricing power versus those that may struggle to do so and thus, potentially see their margins erode.?

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Definitions

Beta: A measure of market risk of an investment option that shows how responsive the investment is to a given market index, such as the Standard & Poor's 500 Index. By definition, the beta of the benchmark is 1.00. An investment with a beta of 1.10 is expected to perform 10% better than the index in up markets and 10% worse in down markets. Usually, higher betas represent riskier investments.

Additional Disclosures

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The Bloomberg U.S. Long Credit Total Return Index measures the performance of investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related debt with at least ten years to maturity. It is composed of a corporate and a non-corporate component that includes non-U.S. agencies, sovereigns, supranationals and local authorities.

Important Information

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