A (stag?)flationary tantrum: assessing the current market sell-off

• We are entering a tough phase of the regime shift, as the risks over economic growth add to the already hot inflationary backdrop. This means that stagflation fears will continue to drive the market and risk assets are likely to remain very volatile, particularly the most indebted companies and those with still excessive valuations.
• Central banks have now acknowledged the inflation problem and changed their tone. They seem ready to act to protect their credibility, at least temporarily.?However, they will probably not go too far and markets have already moved to incorporate their hawkishness.?The extraordinary ECB meeting is a case in point of a central bank struggling to provide the market with a clear monetary compass and framework in a regime shift. In fixed income this calls for a neutral duration stance and a focus?on quality credit and liquidity.
• In DM equities we remain cautious?as the earnings outlook is still too optimistic, in our view, and the risk is to the downside.?The current repricing is taking most of the overvaluation out of the market, but current levels are vulnerable to any deterioration in corporate fundamentals.?Companies’ earnings resilience and pricing power will be key drivers of the great discrimination in equity markets. Our forecast of a possible earnings recession in the EU leads us to?maintain a more careful stance on Europe and supports our preference for US vs. EU equity.
• Regionally, we find Chinese equities more attractive as these are more insulated from the current turmoil emanating from the developed world. They should also benefit from the reopening of the Chinese economy, as well as the country’s lack of inflationary pressure and current policy support.

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