Contact Us Client Login CLIG Site

Developed Markets Quarterly Outlook

May 2022*

Recession Fears Loom Large

Concerns about the pandemic have given way to growing angst over the sharp tightening of global financial conditions in response to the relentless rise in inflation. The war in Ukraine complicated the outlook further by putting additional upward pressure on commodity prices. A slowdown in Chinese demand and supply disruptions due to its zero-COVID policy add yet another drag on global growth. The decisive response required by central banks to tame inflation raises the risk of recession.

As the COVID-19 pandemic gradually recedes from the market’s central focus, the spectre of inflation, sharp monetary tightening and the looming possibility of a recession have taken over as key concerns for investors. The rise in inflation has both supply and demand drivers, which means that it has become much more entrenched than originally anticipated. The initial impetus for inflation came from mounting and persistent supply chain disruptions due to the pandemic-related lockdowns. This was exacerbated by a shift in consumption from services to goods as consumers were restricted in their mobility. As mobility restrictions eased, the release of pent-up consumer demand on the back of excess savings accumulated from government support added additional pressure on prices. The invasion of Ukraine in February of this year provided yet another boost to commodity prices, notably energy and agricultural prices. Finally, wage growth has begun to gather pace given the prolonged increase in inflation.

The complex nature of these factors suggests that inflation is unlikely to peter out simply as a result of the pandemic fading. Instead, it requires decisive corrective action by central banks, especially as their monetary policies have remained extremely accommodative during a period of strong recovery, with real interest rates deeply negative and central bank balance sheets bloated. As some of these factors are outside the reach of central bank policy, there is thus a risk that central banks may choose to tighten even more aggressively than already priced in by markets in order to compensate for this lack of traction.

At the same time, bringing policy rates to zero or even into positive territory requires sharp increases in rates, even if inflation slows by year-end. The solid state of most labor markets generally allows central banks to act with determination (with the exception of the ECB, which fears an unsustainable rise in government borrowing costs). Yet, such a swift adjustment will make it difficult to avoid periods of stagnation and/or recession. On the other hand, a period of softening demand pressures also means that commodity prices and general inflation are likely to recede next year. In fact, the sooner a soft patch sets in, the sooner the tightening cycle can be brought to an end.

Market Strategy: The confluence of negative factors has weighed heavily on global equity markets this year: the MSCI ACWI lost 8.4% during the February to April period, with a notable underperformance of the US by 30bps, which suffered from a heavy tech sell-off (the Nasdaq recorded a 13% loss during the period). This mostly reflected the ramping up of US rate expectations, which affect companies with profits in the far future the most. However, the invasion of Ukraine led to an even greater underperformance of the Eurozone, which lagged the aggregate index by 480bps over the same period. DM commodity exporters generally did well, whereas emerging markets underperformed the ACWI Index by 200bps.

The effects of global monetary tightening and of the invasion of Ukraine do not a priori push in the same direction. In the wake of the invasion, we had made several adjustments to our country allocation: we downgraded the Eurozone to underweight given its proximity to the warzone and its vulnerability to energy supply disruptions. But being more isolated from the direct effects of the conflict, we upgraded the US to overweight again. This consideration outweighed the fact that the US appears on track to face a much more pronounced tightening cycle than the Eurozone. Ultimately, bringing inflation under control swiftly will also pave the way for a sharper recovery. We maintained our previous overweight exposure to commodity-intensive economies such as Canada and Australia. We also remain underweight Switzerland due to its high valuations.

Global Equity Allocation Breakdown


  Chg -2 -1 0 +1 +2
US          
Canada -        
Eurozone          
Switzerland -          
UK -          
Japan          
Australia -          
EM -          

*This publication reflects asset performance up to 29 April, 2022, and macro events and data releases up to 11 May, 2022, unless indicated otherwise.

  Download the Full Report

The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.

REGULATORY INFO

Important Information  |  Form ADV & Disclosures  |  UK Stewardship Code
Capital Requirements  |  Privacy & Cookie Policy

City of London Investment Management Company Limited (“CLIM”) is authorised and regulated for the conduct of investment business within the UK by the Financial Conduct Authority (FCA) and is registered as an Investment Advisor with the United States Securities and Exchange Commission (SEC).
Registered in England and Wales No. 2851236. Registered Office: 77 Gracechurch Street, London, EC3V 0AS, England.

© 2022 City of London Investment Management Company Limited.
All rights reserved.

City of London Investment Management Company Limited (“CLIM”) is authorised and regulated for the conduct of investment business within the UK by the Financial Conduct Authority (FCA) and is registered as an Investment Advisor with the United States Securities and Exchange Commission (SEC). Registered in England and Wales No. 2851236. Registered Office: 77 Gracechurch Street, London, EC3V 0AS, England.

© 2022 City of London Investment Management Company Limited. All rights reserved.