After rebounding from a short-lived pandemic recession, the global economy has faced multiple threats in 2022, triggering fears of a prolonged slowdown. Anthony Okolie speaks with Jing Roy, Portfolio Manager, TD Asset Management, about her outlook on equity markets and the economy.
Originally published on May 10, 2022
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- Jing, the last few weeks and months have been pretty turbulent for both investors and financial markets, and it appears that this volatility isn't going away anytime soon. So what has got your attention right now and why?
- Yeah. So what has my attention right now is really to predict the future path of the asset returns, and there are broadly three things I am focusing right now. Number one, inflation; number two, consumer spending and corporate profits; and number three is financial conditions. I think I'll start with inflation. When inflation is high, investors will require higher returns from their investments to preserve the purchasing power.
One way to get the higher returns is to pay less for the investment assets upfront. So as a result, we're seeing a decline in asset prices from bonds to equities and, in some cases, real assets. I also look at consumer spending and corporate profits to determine the health of the broader economy. In fact, they're the two sides of the same coin. Think about this, because consumer spending typically translates to higher corporate profits, which in turn supports employment and ultimately higher consumer spending.
The last thing I look at is, because we're now in a tightening cycle, I look at the financial conditions to monitor the availability of credit in the system. A lack of credit tends to cause a seizure of the financial system and lead to forced selling of financial assets at prices that are divorced from fundamentals.
ANTHONY OKOLIE: OK. So given that backdrop, what about stock prices? We've seen them. They've pulled back from the highs from last year. Do you think we're oversold yet, or is there more to come?
- I think investors need to stay a little bit patient with where the stock prices are at. In order for the equity market to stabilize, we need to have some clarity on three important questions. Number one, is the inflation peaking? Next, can central bank tame inflation without causing a deep recession? And lastly, can the financial system cope with less credit in the face of geopolitics and supply chain shocks?
So what we are seeing now is early sign that inflation is starting to moderate. This is very encouraging, because it allows central banks to be less aggressive in raising rates and suppress aggregate demand. And this, in turn, lowers the risk of a deeper recession and liquidity crunch. But all of this needs time to play out.
ANTHONY OKOLIE: OK. So as you mentioned, inflation is certainly still high. Central banks will continue to aggressively tighten monetary policy. There's growing concerns of a potential global economic slowdown. How do you see this playing out?
- Well, it's really tough to be a central banker right now. Their policy tools are blunt, because they work through aggregate demand but have far less impact on supply. And this issue is particularly acute today, because we're in a supply-constrained world. A slowdown is not only unavoidable but also the intended outcome of the central bank policy. So if done right, it sets the stage for another leg of economic expansion.
The Fed actually engineered a soft landing in '94 under Greenspan. Can the Fed do it again? I think it's a lot more difficult this time because of the inherent limitation of the Fed policy tools and the higher level of inflation as we entered this hiking cycle. So unsurprisingly, the equity market is currently pricing the probability of a mild recession. And equity drawdowns are typically more severe during a financial led kind of recession or caused by a policy error.
At this point, the risk of a financial recession is rather contained, in my opinion, because of a fortified banking system and a healthy consumer balance sheet. On the other hand, while the risk of a severe recession caused by policy era defined as central bank overtightening is also low at the moment, the equity market will respond quite negatively if inflation expectations becomes unanchored through wage price spiral or further supply shocks.
ANTHONY OKOLIE: So based on your outlook, where are you finding some opportunities right now?
- As investors, this is the phase where we need to focus on capital preservation and reduce the overall risk in the investment portfolio. In this environment, we like defensive sectors, such as staples, utilities, and telecom, because they tend to outperform because of the stable cash flow they generate and the secure dividends. And in fixed income, we like short-duration investment-grade credit and try to hold them to maturity in order to take advantage of the higher yield and avoid capital loss. In addition, since we're experiencing very high asset class correlations with bonds and equity both getting hurt from the higher interest rate, we need to look for offsets through alternative investment strategies.
What we do is we buy portfolio insurance through put options and increase our US dollar exposure against cyclical currencies. We can also temper the volatility of our portfolio at the same time earning alternative risk premia by investing private assets. When bond yields stabilize, technology companies that can grow profitably will start to work again. When that time comes, we want to make sure that we have the capital to deploy and secure the attractive returns for years to come.
ANTHONY OKOLIE: OK. Looking ahead, what are some of the key things that investors should take away?
- Investing is not very easy, but it's going to get a lot harder this year. We're entering a period of slowdown and a choppy environment. It's very important for us to keep the risk mindset and manage the risk appropriately in the portfolio and focus on capital preservation.
ANTHONY OKOLIE: Jing, thank you very much for your time.
- Thank you.
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