While the volatile mix of geopolitical risks, high inflation rates and diverging monetary policies continue to keep markets on edge, Invesco's economists and investment strategists forecast further price increases and weaker global growth, but no recession, in their investment outlook for the second half of 2022.
In their baseline scenario, Invesco experts assume that the military conflict between Russia and Ukraine will continue without escalation that could lead to an abrupt disruption of Russian energy supplies to Europe. Inflation will peak in mid-2022 and then slowly ease in the U.S. and other major industrialized countries as falling real incomes and monetary tightening put pressure on demand. Due to high commodity prices, they expect growth to remain weak for the rest of the year, followed by a return to trend growth in 2023.
As Henning Stein, Global Head of Thought Leadership& Market Strategy, explains, the extent of the downturn will also depend on central banks' ability to tighten monetary policy enough to cool the economy and lower inflation, but not so much that their respective economies slide into recession.
With an uninterrupted supply of energy, but energy prices remaining high, the Invesco experts expect high inflation and weaker growth in Europe over the rest of 2022 and into 2023 – a difficult combination that could lead to the European Central Bank (ECB) raising interest rates only once or twice in 2022.
Positive stimulus in the USA
In the U.S., continued positive stimulus from the end of pandemic-related restrictions should support growth momentum, although the Federal Reserve (Fed) aims to reach a neutral policy rate and shrink its balance sheet as soon as possible in 2022. From the Fed, Invesco experts expect a tightening of monetary policy in line with market expectations, which should keep the key interest rate in a range of 2.50 to 3.00 in the first quarter of 2023. This would leave the Fed's monetary policy stance neutral to slightly restrictive. As a result, the overall yield curve would flatten by the end of the year.
Compared with the major Western industrialized countries, China remains in a distinctly different phase of the economic cycle – mainly due to the ongoing pandemic-related challenges. However, the Invesco experts expect growth to accelerate over the rest of the year, boosted by monetary and fiscal policy stimulus, followed by a return to potential growth.
Further rate hikes are forecast for some emerging markets, such as Russia, Brazil and Mexico, where higher inflation has already led to aggressive rate hikes in the past year. In contrast, large emerging Asian economies, where inflation is not elevated, may be able to continue to keep interest rate tightening limited this year and thus maintain reasonable levels of economic growth.
Two Alternative Scenarios
In their investment outlook, Invesco's investment experts also outline two alternative scenarios that are considered less likely to occur. In the negative scenario, an energy shock would result from a cessation of Russian energy supplies, leading to higher global inflation and weaker growth, and would be associated with higher recession risk.
In a positive scenario, a surprise de-escalation of the military conflict in Ukraine would reduce current geopolitical risk premiums in energy and commodity markets. According to the Invesco experts, this would argue for higher global growth and declining inflation worldwide, but also for a stronger tightening of monetary policy in most of the major industrialized countries.
In terms of the market environment, Invesco experts expect market volatility to be higher on average later in 2022 than in 2021, as long as markets digest the tighter monetary environment. In their baseline scenario, they forecast modest returns with little spread in returns between bonds, credit assets and equities.
In this environment, they believe there is a strong case for overweighting equities versus bonds. With growth momentum slowing and inflation nearing its peak, they would expect defensive sectors with quality characteristics such as IT, communications services, healthcare, real estate and consumer staples, as well as large caps, to outperform moderately. In regional terms, they would have a preference for U.S. stocks over stocks in other developed countries, as the global growth slowdown argues for a focus on regions with lower cyclical sensitivity and better cost structures.
For investors, it is important to remain calm even if the markets sell off, says Henning Stein: "Investors should continue to act strategically and avoid tactical actionism. In China, the opportunities are greater than the risks. I see good opportunities for entry."
In the search for yield in the bond sector, Invesco experts are focusing on longer duration rather than higher credit risk. As the cycle progresses, credit spreads are expected to widen, especially in lower-rated segments, they say. They consider credit assets from emerging markets to be attractively valued at present.
Outlook for non-cash assets favorable overall
In Alternatives, buyout and venture strategies may be under pressure from relatively high valuations and increasing "dry powder" (capital committed by investors but not yet invested). With the potential for a sustained upswing in global trade, passenger traffic and office occupancy combined with relatively attractive valuations and inflation protection, Invesco experts believe the outlook for real assets is favorable overall. These would normally respond positively to inflation, because higher prices normally lead to higher revenues and appreciation of physical assets.
"In our baseline scenario, higher-than-average inflation and several interest rate hikes argue for building a portfolio that can generate positive nominal returns even in a difficult and unfamiliar environment," says Stein. "According to our forward-looking risk model, a traditional 60/40 portfolio can outperform by adding inflation-sensitive assets such as real estate and commodities under different macro and market conditions."