Fan Yu
FAN YU is an expert in finance and economics and has contributed analyses on China’s economy since 2015.
Gauging Investor Sentiment Fears of stagflation are at their highest since 2008
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he financial markets are reeling. Those who followed the proverbial “sell in May and go away” are sitting in a relatively good position. For everyone else? The U.S. stock market officially entered bear market territory, and the Federal Reserve delivered a massive 75 basis point rate increase, the biggest benchmark rate boost since 1994. Several well-known technology companies have announced layoffs. With the first of many expected rate hikes behind us, how are investors feeling heading into July? Do we have market capitulation yet? The Fed acted forcefully in an attempt to bring down inflation, with a rate cut that was widely expected by the market, yet contradicted initial Fed remarks that a 75 basis point increase was off the table. Regardless, inflation readings were higher than expected, and the central bank had to act, with Chairman Jerome Powell using the word “nimble” to describe actions going forward. “We now see a steeper path for rate increases this year, to a higher peak rate around 4%” by the end of the year, Morgan Stanley analysts wrote in a June 15 note to clients. “The key question now is how quickly do they stop hiking rates, and prepare for cuts should they see a material slowing.” The last sentence alludes to the dreaded recession, which, by some measures, is already upon us. There’s anecdotal evidence everywhere. Companies have announced mass layoffs, certain consumer discretionary product inventories are building, and businesses are cutting budgets and freezing hirings. May U.S. retail sales, which were released in mid-June, came in far below expectations as consumers pulled back on spending. For investors, the question is how
On an absolute basis, professional investors have the highest conviction on cash, followed by the health care sector, commodities, and the energy. they should be positioned. We turn to Bank of America’s most recent Global Fund Manager Survey, which polls how professional fund managers are thinking in June. As you would expect, professional investors are very, very pessimistic. Fears of stagflation—a period of high inflation and low economic growth— are at their highest since 2008, while corporate profit expectations are also at their lowest since 2008. In short, the outlook is negative. On an absolute basis, professional investors have the highest conviction on cash, followed by the health care sector, commodities, and energy. Banking and real estate were also squarely on the “bullish” side of the ledger. Being overweight in cash is a proxy for staying on the sidelines and not investing. Commodities and energy typically do well in inflationary peri-
ods. Banks typically thrive as interest rates go up, increasing their net interest margin, or the spread between the rate at which they lend and the rate at which they earn. Real estate, being a hard asset, typically does well in inflationary periods, and there’s also a relative shortage of quality housing in the United States, although residential real estate prices will ease from the ludicrous pace of growth over the past 12 months. And lastly, the health care sector is somewhat economically insensitive and has been under-invested over the past few decades. The sectors professional investors are most bearish on are somewhat surprising. Bonds received the most underweight ranking, followed by consumer discretionary and utilities. Bonds and utilities are typically havens for when the stock market has a downturn, but in the current environment, they’re anything but safe havens. Utility companies pay a steady dividend and are fairly stable, but with interest rates rising, they provide a relatively unattractive yield. Consumer discretionary is self-explanatory. Those companies won’t do well as consumers tighten their belts. Scott Minerd, chief investment officer of Guggenheim Partners, thinks if investors are into bonds, they need to hold high-quality, investment-grade corporate debt and government debt. “Recession means you are going to have wider credit spreads,” Minerd told Bloomberg TV. “There are cracks appearing in the credit world, and the worst is probably not over there.” He said this is a good time to put money to work in Treasury bonds. As for that much-hoped-for “soft landing”? That’s effectively out the window. The Fed, judging by its actions and messaging this month, is signaling a high chance of recession. Investors should prepare accordingly. I N S I G H T June 24–30, 2022 49
