Financial markets: Is the road to recovery in sight?

The NASDAQ Composite, which represents the technology stocks, led the market on the way up over the past decade. It is already down almost 30 percent from its peak. The key aspect is if the economy will experience a recession, or not.

In the eight bear markets since World War II that weren’t accompanied by recessions, the average decline in the S&P was 24 percent. But in the nine-year markets over the same period of time that were accompanied by recessions, the average decline was a much larger 35 percent. Simplistically that should mean that if there isn’t a recession, then the bottom in the market isn’t too far away.

Why do you believe the extent of the global economic recovery is being underestimated?

To put it simply, the global economic recovery is highly uncertain; impossible to predict and therefore neither over nor understated. Even if Covid-19 returns to plague us (which sadly it appears to be doing in some parts of the world), in the vast majority of countries, authorities won’t lock down like they did before. While the global economy will continue to normalise from the aftermath of the pandemic, and there is plenty of catch up to be done.

The Federal Reserve issued the biggest rate hike in 22 years. What is your view on how it will impact financial markets? How will this help in taming inflation?

It’s true that at 50 basis points, it was the biggest hike by the Federal Reserve in 22 years. But, because the fed funds rate was already extremely low (an all-time low), even a 50 basis point rate hike only takes the fed funds rate back to 1 percent, which is less than half its average of the last three decades.

That being said, Fed officials have been busy communicating their aggressive tightening plans since 21 December, and that communication has already moved the market to reprice the 10-year treasury yield from 0.5 percent to around 3 percent. This is helping tame some aspects of inflation, because treasury rates are the benchmark for most commercial and mortgage loans in the United States. But for other things in the basket, like food and transportation, higher rates will be less impactful.

Which companies do you believe offer the best investment prospects?

Share prices of large technology companies have underperformed the broader market this year, because they were considerably more expensive than the broader market when it peaked. They were also (and still are) the largest constituents of the benchmark equity indices that Exchange Traded Funds (ETFs) replicate. So as investors became concerned about the Fed raising rates and the war in Ukraine, they sold those ETFs, and the large technology company share prices fell more.

However, having fallen in price so much, we find that on several key valuation metrics, those large technology companies are no more expensive than the broader market today. They still have significantly above-average growth profiles, because the global economy continues to digitalise. Then, although inflation will come down from its currently high level, it won’t go all the way back to what it was pre-Covid. It will probably be around twice of what it was before.

Also, with carbon emission targets to reduce global warming, investment in fossil fuel extraction will be low to nil. Ironically, that should keep oil and coal prices at levels where it is very profitable for producers to extract them. With inflation correcting lower over time, this is an attractive entry point that we will seek to exploit in our portfolios. Moreover, inflation should start to roll over as the commodity supply-chain bottleneck effects from the pandemic and the war in Ukraine start to fade. Julius Baer Research does not expect a commodity super cycle, and there is no general physical shortage of commodities.

The oil market has undergone a lot of fluctuation recently. Do you see this continuing?

There is plenty of oil around, the issue is getting it, and shipping it. For example, the United Kingdom could be self-sufficient in its energy needs, but as it has clamped down on production in the North Sea, it is far from self-sufficient.

Meanwhile and ironically, oil from formerly objectionable producers like Venezuela is now acceptable. It is a confusing and illogical picture, that means prices continue to fluctuate. Longer-term, as passenger cars transition from combustion engine to electric motors, a quarter of demand for oil will slowly disappear. Technologies should emerge to replace combustion engines used in other applications too. So on a 10-year view, the oil price should be much lower than it is today.

Sustainable investments are growing in traction. Do you see this as a passing phase?

For sure ESG investing is here to stay. The danger is if it becomes excessively bureaucratic, to the extent that it is uneconomical. That would not work, because by definition; investing is an activity done to produce a positive return. Also, for emerging countries, it is very difficult to shift quickly to fossil fuel-free transportation and electricity. I am hopeful there will be a happy medium where we can become more caring of the environment and generate a profit at the same time.

Finally, what is your advice to investors in such a tumultuous market environment? Would you recommend to stay invested?

Yes, but there is no long-term gain without short-term pain. The S&P 500 has averaged a 10 percent total annual return over the past three decades. And yet along the way, there were two bear markets of more than 50 percent, and another two of more than 20 percent. So buying and holding the S&P is the way to go. It is like a very good fund manager – it naturally pushed the best companies to the top, and the worst companies out. Finally, I would add that in the current environment, make sure you have cash for a dip, and don’t have any leverage.