Over the last 30 years, broad asset returns have rarely been weaker as financial markets increasingly price in ‘stagflation’. What does this mean for asset allocations?
Earnings forecasts have mostly flatlined as analysts factor in waning demand. Even so, we believe forecasts for Europe ex-UK are still too optimistic. The boost to earnings growth in commodity sectors is likely to be only temporary. European energy sector earnings could almost double in 2022 before falling for the next two years.
After a period of strong outperformance, we deepened our short in Europe. European equities face headwinds from slowing growth and rising inflation; an inflation-focused ECB; geopolitical risk; and over-optimistic earnings forecasts. Our long exposures are focused on Asia. We see Japan as offering quality value.
In China, we see deeply attractive valuations, particularly in the tech sector after Beijing follows through on its promise to do ‘whatever it takes’ to support growth. We expect good earnings growth. Finally, the clear turn in China’s credit impulse should create a supportive setting for Chinese businesses.
While a new regime of higher inflation should bring with it higher policy rates and higher long-dated yields, market moves have allowed us to reduce our underweight in duration. For valuation reasons, we clipped back our short positions in the US and Europe, while maintaining our short in Japanese sovereign bonds.
Fundamentally, however, we remain cautious on long duration assets. There is room for inflation expectations to rise, in addition to mounting term premia as central banks tighten rates.
Disclaimer
