It was great to see some of you at our most recent Family Office CIO Round Table where we discussed a range of topics, including UK Activism, Inflation & Commodities, Secondary Private Tech SPVs, as well as opportunities in distressed sovereign debt. As always, we look forward to connecting with many of you at our next EMEA (19th May) and North American (24th May) Round Tables. As always, if you’re interested in taking part in these events, please get in touch.
For those of you in London in June, we hope that we can see you at our family office drinks.
The Big Picture
With our Asset Allocation Committee (AAC) and Equity Market Outlooks for the second quarter both now available, we can confirm that our view on equities has become more cautious over the past two months. While U.S. earnings growth, in particular, is likely to remain resilient, and we still believe equities have the potential to deliver positive return opportunities this year, our views on how best to manage equity exposure have changed significantly. Our views on large versus small caps and value versus growth are now more balanced. We now favor higher-quality, lower-beta, income-oriented stocks across both styles.
A more favorable view of non-U.S. markets, and particularly Europe, where inflationary pressures had looked less serious before Russia’s invasion of Ukraine, has switched to a preference for the U.S. The return of structurally higher inflation when economic growth is slowing from high COVID-recovery levels was already a concern, before being worsened by the Ukraine crisis.
While it is not our base case, the AAC notes that the current setup raises the risk of near-term recession, either because central banks lose control of rising prices or tighten too aggressively in an attempt to arrest them. At its March meeting, the U.S. Federal Reserve’s dot plot front-loaded its projected rate hikes for this tightening cycle. Even without recession, we think this less favorable growth-inflation-rates mix potentially leaves investors facing a new regime that is very different from the one that has prevailed over the past two decades—a shift that we’ve mentioned in a number of past newsletters and other commentary.
In this new regime, we believe the effectiveness of long-duration, investment grade government bonds as a “natural” hedge for riskier assets is likely to fade as equity-bond correlations turn positive. We believe we may be entering an extended period during which real assets, benefitting from the inflationary headwind, could generally perform better than financial assets. This raises important long-term considerations for asset allocation.
The Fed Has Front-Loaded This Cycle’s Projected Rate Hikes
Median Fed Funds Rate projections of Federal Open Market Committee (FOMC) members
Source: U.S. Federal Reserve. As of March 16, 2022. Information is as of the date indicated and subject to change without notice. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
The Close-Up
Globalization of the economy and its supply chains appears to have stalled a couple of years before the Great Financial Crisis. The impact of that crisis on global capital flows started a reversal of the long-running trend. The rising costs of manufacturing in China removed some of the benefits of globalization. The desire to localize supply chains to better manage social and environmental risks added further pressure, as did the increasing split of the semiconductor and broader tech industry based on security concerns.
Then came the COVID-19 pandemic, which reminded business leaders of the advantages of more local and more diversified, “just-in-case” supply chains, and the Ukraine crisis, which has revived the prospect of a return to Cold War-style “spheres of influence.” Could the equity valuation multiples that were possible during the past 30 years of globalization be a thing of the past?
What if the Ukraine Crisis Is the Final Nail in the Coffin of Globalization?
World Bank Total Trade Good/Service % of GDP World
Fall of Berlin Wall, Rise of the S&P 500 Multiple
Source: Bloomberg, Evercore ISI Research. As of March 2022. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
The Snapshot
In commodity industries, it’s often said that “the best cure for high prices is high prices”—because high prices has tended to incentivize capital expenditure for increased production. That no longer appears to be the case with fossil fuels: shareholders’ demand for spending discipline and income, together with the move toward net-zero emissions from regulators and investors, could constrain new supply and feed inflation.
New Extraction Capacity Lags the Rising Oil Price
Source: Bloomberg. As of January 2022. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Past performance is no guarantee of future results.
We hope you find this useful and if there are any specific topics or themes you would like us to cover, please do not hesitate to get in touch.
