Inflation Has Knocked the Wind Out of Equities; But Megatrends Remain in Play

Cape Town, 2 December 2022: High inflation and a tighter monetary policy are expected to weigh on developed market equities throughout 2023; but investors can still make money by seeking out thematic opportunities within long-term megatrends.

Cape Town, 2 December 2022: The equity market headwinds in 2022 of higher inflation and higher interest rates look likely to persist into 2023, but there are opportunities for investors if they seek out thematic opportunities within long-term megatrends.


“The past 12-months have been challenging, with central banks aggressively raising interest rates to curb inflation, and escalating geopolitical tensions that caused oil, gas and food prices to rise, seemingly with no end in sight,” says Nico Katzke, Head of Portfolio Solutions at Satrix, during a Satrix IndexMore ‘market outlook’ webinar held in November 2022.


Laura Cooper, Senior Macro Investment Strategist at BlackRock agrees, summarising the key events that influenced global financial markets this year as central banks acting aggressively to curb inflation; the Russian invasion of Ukraine and consequent energy price/supply shocks; and ongoing pandemic restrictions in China. “These challenging macro dynamics fed into asset class performance, and it is quite notable that there have been simultaneous and steep drawdowns for global equity and bond asset classes this year – the first time this has happened in over four decades,” Cooper says.


The debate keeping asset managers busy as the New Year looms is whether traditional asset allocations need to be rethought in light of the aggressive interest rate tightening cycles adopted by developed market central banks. “The US Federal Reserve has raised rates by about 375 basis points since March,” says Cooper, but BlackRock is not among the growing herd that believes the Fed’s rate hiking cycle is over. Rates could go higher in early 2023, pushing the US economy into recession.


“Given that the S&P 500 has rallied more than 10% off its October 2022 lows, we think that developed market equities are even further away from pricing in even a mild recession, meaning that there is more downside in stocks at this juncture,” says Cooper. The sensible ‘play’ is thus for investors to stay tactically underweight in developed market equities without neglecting the sectors that will benefit from thematic, structural and near-term trends. These sectors include energy, financials, and health care.


“Overall, looking to 2023, the transition to a new macro regime is well underway as the great moderation of low inflation and low macro volatility has come to an end, leaving investors to position for greater volatility,” notes Cooper. Kingsley Williams, Chief Investment Officer at Satrix, says the key to investing through volatility is for investors to understand their investment time horizons and structure portfolios for the level of risk they are willing to take. “As your investment horizon increases, say to 10 years, the probability of loss reduces down to anywhere from 7% all the way down to 0%,” says Williams. “As you give risky assets time to grow and realise their expected returns, you will find inflation-beating returns materialise with a much greater degree of confidence.”


Financial market returns are primarily derived from the exposure that investors have to various asset classes. “This is why we focus a lot of our time and energy on optimising our strategic asset allocations, particularly within our multi-asset Balanced Funds, and creating different solutions to meet clients’ different risk profiles,” Williams says. “These solutions are rebalanced to reflect strategic asset allocations periodically because trying to time markets is incredibly difficult to get right consistently.” The tough decisions about which asset classes to track; what investment strategies to utilise; and what weights and combinations of those required to deliver an appropriate outcome are all taken by the balanced fund’s portfolio managers.


Rob Powell, Head of Thematic and Sector Product Strategy at BlackRock, says that the global asset manager’s five long-term megatrends remain intact, but that the impact of short-term shocks have to be factored in. As such, BlackRock conducts an annual review on its megatrends to accommodate developments like permanent behavioural changes linked to the pandemic; investors’ attentions shifting from growth to value shares; and the conflict in Russia-Ukraine, to name a few. For example, has the pandemic upstaged the long-term urbanisation megatrend? The answer is ‘no’, and especially not for emerging markets. 


Fund managers must construct portfolios that properly reflect the disruption that long-term megatrends cause. The trick, according to Powell, is to translating each megatrend into a narrower and more implementable opportunity set. Take climate change, for example. “The biggest development in how we think about the megatrends is the increased focus on climate change and resource scarcity,” says Powell. “One of the main challenges related to climate change is rising carbon emissions. And one of the main contributors to carbon emissions is the power sector. By focusing on renewable power alternatives to traditional fossil fuel energy sources and the industries and companies that are providing the necessary products and solutions, investors can position themselves to benefit from the consumer and regulatory focus on climate change.” 


BlackRock shared various 2023 insights during the Satrix IndexMore webinar, including that investors were turning positive on emerging market equities; that BlackRock was underweight in developed market equities due to the sharp withdrawal of accommodative financial conditions and expected headwinds on corporate earnings; and that bonds and corporate credit were more compelling than equities for the first time in over a decade. “The dynamics going forward really capture our key investment thesis for 2023; we are in a new macro regime in which investors will have to be more granular and selective in seeking portfolio allocations,” concludes Powell.



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