Inflationary pressures are intensifying The central banks will be forced to increase the envelope of monetary tightening We are maintaining our forecast of a marked slowdown of growth In view of this economic situation, Groupama AM is adjusting its investment strategy.
Economic scenario: prospect of marked slowdown
The developed countries are currently adjusting their economic model in order to tackle structural challenges (climate change, demographic ageing etc.) and to accelerate their strategic independence (defence, digital, energy and food), . These transition periods are “by nature” inflationary because they demand resources (raw materials and human capital) that are not yet available in sufficient quantities. For that reason, inflation will persist, and growth rates will enter a long period of alternating “Stop-Go” phases, with “slowdowns” in response to surges in inflation, followed by “recovery” phases, boosted by budget stimulus as governments invest in support these transitions.
Currently, the global economy is in one of these slowdown phases. This slowdown will be significant – even if it is not yet perceptible in the economic data – especially given that the environment has recently worsened in two respects. First, the economic consequences of the conflict in Ukraine have been amplified by the increasingly severe sanctions and the risk of further escalation. Second, inflationary pressures have intensified with the rising prices of agricultural products, the increased congestion in global ports and the increasingly exceptional stresses on the American labour market..
These growing inflationary pressures accentuate the challenge for central banks. Central banks are still obliged to accelerate their monetary tightening. In particular, the Fed (American central bank) is unable to reduce the “overheating” of the US economy without causing a marked slowdown. For that reason we have again lowered our growth forecasts, while maintaining a downward balance of risks. We now project growth of 2.5% this year in the Eurozone and 1.5% next year. In the United States, we anticipate 2,2% and 1,7% respectively, and in China 5/0% and 4.5%. Inflation is expected to slow down, but it will remain at a high level. So, in both the Eurozone and the United States, we predict an inflation rate of 7.0% in 2022 and 4/5% in 2023.
Investment strategy: tactical prudence and strategic positioning on yield strategies and on assets that provide hedging against inflation
Monetary tightening – in particular, the shrinking of the Fed’s balance sheet – causes a reconstitution of real interest rates. That is why, for long-term rates, the overall trajectory remains upward. However, in the short term, with the prospect of macroeconomic slowdown, a [pause in this upward trajectory is expected, before rates again start to rise. The fixed-income markets are undergoing a paradigm shift: in an environment of structural recovery of investment, the “equilibrium” interest rates are expected to rise.
Our positioning on equity is prudent for three reasons. First, the economic slowdown is expected to stem the rise of corporate profits. This stagnation effect has already been taken into account in share prices but has not yet been taken on-board by the consensus of analysts. An adjustment is therefore probable. Second, as long as inflation and interest rates have not stabilized, share prices are unlikely to show strong growth. This is because price / earnings ratios tend to decline during periods of high inflation. Finally, the draining of liquidity from the financial system will regenerate the liquidity premium, which penalizes risky assets.
In this environment of long-term inflation and lowered expectations of growth, we are adjusting our investment strategy. We are now prioritizing three types of management strategy :
- First, we are focusing on tactical agility or contrarian strategies. These strategies make us less dependent on macroeconomic data and on market movements that are sometimes erratic and not correlated to actual trends, whether in the fixed-income or equity universe.
- Second, we are favouring assets that hedge against inflation, including short-duration bonds (which are less sensitive to variations in interest rates), inflation-linked bonds and tangible assets. In the equity universe, international diversification and “value stocks” – stocks that appear undervalued – should be preferred in periods of rising interest rates and high inflation.
- Finally, we are concentrating our attention on yield strategies, both on the equity and fixed-income markets. Credit spreads have widened considerably, creating numerous opportunities in the fixed-income universe.
 Our balance of risks indicates the most probable direction of any adjustment of our growth forecasts.. For example, a “downward” balance of risks means that the probability of revising growth rates downwards is higher than the probability of an upward revision.