Home Business Markets, investing in the middle of the cycle: the hour of selectivity has come

Markets, investing in the middle of the cycle: the hour of selectivity has come

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Selectivity. This is the watchword for invest on markets financial, with a global scenario that appears to be a half cycle. The strong, albeit uneven, rebound in the various countries this year is likely to give way to more moderate synchronous growth, albeit still above trend, in 2022. Not only growth but also inflation and policy support could moderate the pace. The global pandemic also appears to be in retreat. This general picture emerged from the recent report published by PIMCO.

The peaks are behind

L’world economy is currently a half of the cycle and leaves behind the maximum levels of the aforementioned four factors. From an asset allocation perspective, this means that growth-oriented assets such as equities and credit can still offer relatively attractive returns. However, greater dispersion is expected across sectors and regions. Differentiation and bottom-up selection within asset classes, such as country, sector and issuer levels, will in all likelihood be crucial to achieving strong returns in the current environment.

Fortunately, the worst of the pandemic world seems to be behind us. THE supports tax, which are naturally linked to expiration dates or employment levels, they are decaying and the tax impulse is bound to turn negative, as we have already seen in China. On the side of the monetary policy, some central banks have taken the first steps towards normalization, by reducing securities purchases or by raising rates. In the United States, the Federal Reserve in June indicated its intention to begin discussing tapering at upcoming meetings and, according to the forecasts reported in the dot plot, the roadmap towards future rate hikes is anticipated. It seems plausible that central banks in major developed markets will start raising rates in 2023.

Fears about inflation

L’inflation surprised on the upside and triggered fears. The impression is that it is a ‘soaring transitory due to base effects, i.e. year-over-year comparison, supply-side bottlenecks and temporary shortages, which are also expected to moderate in 2022. The lack of support from both fiscal and monetary policy will put a brake on on economic growth in the next year, despite the easy earnings associated with reopening. Developed market real GDP growth of 6% can be expected in 2021 (fourth quarter to fourth quarter) and then moderates to below 3% in 2022. The slower pace of vaccination in emerging markets has delayed its recovery and for these markets, GDP growth can be estimated to reach 3.5% in 2021 and then accelerate to 5% in 2022 (fourth quarter on fourth quarter).

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After peak this year, i taxi of growth gods markets developed will reduce the pace compared to current levels but in absolute terms growth will remain high over the cyclical horizon. Unexpressed demand, high levels of consumer savings and healthy corporate leverage ratios provide a springboard for private sector-led growth. A interesting context for growth-oriented assets. In general, PIMCO analyzes indicate that we are in the middle of the expansionary economic cycle and this is reflected in equity valuations. Historically, robust but differentiated returns have been observed in equity markets during these phases of the cycle. Credit also tends to perform well in such environments but often underperforms equities on a risk-adjusted basis. The US dollar, on the other hand, has traditionally recorded negative returns in these phases.

The importance of being invested

The half of the expansion cycle typically it is a stage where it is desirable to be invested. However, in light of squeezed risk premia in the markets, investors will need to rely more on sector and stock selection to drive returns. This is even more true in the rapidly changing post-pandemic global context in which there is ample uncertainty regarding potential outcomes and traditional investment methods may not be easy to apply.

ESG continues to grow

A trend that is gaining ground with the current mid-cycle recovery is that of investments ESG. According to UN data, more than 110 countries, which together represent over 70% of world GDP, are committed to a future with zero emissions. It will be an evolution that will unfold over several decades and that with the change in consumption and investments should generate a robust demand for certain goods and materials (for example, renewable energy, semiconductors, forests and pulp pulp products). At the same time, the trend towards zero emissions is likely for certain companies (for example those in the traditional oil and gas sectors that have not yet adapted to the change in the energy mix of the future) will lead to a risky transition or long contractions. Moving towards a greener future requires the adoption of new technologies and new energy sources as well as updates of regulations and policies.

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About the governance, governments and businesses could do more investments within their borders to shorten supply chains and secure the ability to produce strategic goods such as semiconductors, batteries or medical supplies. In these cases, national security or economic interests may tend to override economic reasons and we may therefore see more investment than would otherwise be necessary. Furthermore, several sectors that suffered in the previous cycle and had to go through intense aggregations are regaining bargaining power with their customers, shipping is one example. Today, in fact, the structures of some sectors are more concentrated and this apparently entails better supply discipline, longer-term contracts and pricing power.

The expert’s conclusions

“We believe we are a half of the business cycle and, in the face of this judgment – he comments Geraldine Sundstrom, Portfolio Manager Asset Allocation of PIMCO – we are overweight on the risk in portfolios, favoring in general the actions relative to other risky assets based on relative valuations. Following last year’s robust rally, we are placing emphasis on tactical flexibility as well as sector and stock selection. We are overweight equities, focusing on companies that are likely to benefit from disruptive long-term changes driven by technology, geopolitical and ESG-related factors. Geographically, we favor the United States, Japan and Asian emerging markets, where many of the aforementioned companies are located. In identifying the main investment themes and selecting individual names, we pay close attention to aspects related to ESG factors. In terms of duration rates, we expect to stay close to base, with a modest underweight to our benchmarks. We expect rates to remain confined to a narrow range for the foreseeable future as central banks are inclined to follow a slow path towards a more restrictive policy, although yield levels are likely to be at the lower end of the range at the moment. That said, we expect to tactically adjust positioning as market levels change and we are aware of the potential diversification benefit offered by duration in the portfolio environment ”.

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“On the credit we have a selectively overweight positioning, with an emphasis on bottom-up issuer selection – concludes Sundstrom – we continue to favor real estate credit in light of the robust fundamentals framework but we see selected opportunities in emerging markets and corporate credit despite compressed spreads. For real assets, our basic view continues to be that the recent increase in inflation is transitory, however, in the face of supply / demand imbalances and stimulus policies, the risk of rising inflation has increased. We focus our exposure to real assets on industrial metals and real estate funds, which should benefit from the reopening of ongoing economies. We currently have a neutral stance on TIPS as implied breakeven inflation levels are close to the long-term target of central banks. On the currency front, the US dollar appears expensive relative to most developed and emerging market currencies and therefore we are underweight the greenback in portfolios. Many emerging market currencies appear particularly interesting from a valuation point of view but the ongoing challenges on the COVID front in those economies require caution ”.

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