Another downside macro risk to consider is the threat of an escalating Russia/Ukraine conflict, which could force European nations into a full-on phaseout of Russian gas imports (not just oil). Finally, rising global uncertainty has begun to weigh on the corporate earnings outlook, with many company profit warnings precipitating sharp stock sell-offs, and earnings expectations have room for further downward adjustment.
A “soft-landing” economic scenario, with inflation moderating globally without significantly denting growth, is not our base case, but it is an upside risk that should not be ruled out. In the US, there are some indications of inflation potentially peaking (or at least abating), such as the inventory/sales of goods ratio appearing to have bottomed. While services inflation has been strong due to economic reopening pressures driving brisk demand, early signs of a slowdown in the housing market will likely feed through to shelter inflation.
China’s government is implementing a number of easing policies in an effort to counter a contraction in the nation’s economy, with some senior Chinese officials pushing for more steps in that direction. However, China’s “zero-COVID” stance could stymie the effective transmission of any such stimulus measures.
While the fiscal impulse is lacking in most regions globally, at least relative to COVID-era largesse, fiscal policy remains expansionary in the European Union and in the UK, where there is a long tail of prior programs and subsidies aimed at mitigating the impact of cost-of-living increases. The prospect of further fiscal easing in the second half of the year is an upside risk, particularly in China and Europe, and could partially offset the anticipated global growth slowdown.
Investment implications for insurers
Focus on core fixed income amid higher volatility — From a yield perspective, we think US interest rates and investment-grade corporate bonds — generally considered “core” fixed income holdings — stack up well against most risk assets right now. At current valuation levels, reserve-backing fixed income assets have the potential to dampen overall portfolio volatility and provide some degree of protection against further equity market sell-offs as the global cycle softens.
Be cautious with surplus fixed income — We think recent credit spread widening has further to go in high-yield fixed income assets if, as we expect, the global economy slows over the next 6 – 12 months. That being said, we see select opportunities in convertible bonds, structured credit, short-duration credit, and housing-related assets.
Tilt toward quality in equities — We expect the global cycle to slow, with liquidity being drained from the financial system, and therefore prefer a moderate underweight to equities and a bias toward quality as opposed to any particular market sector. We think companies with pricing power, long-term margin stability, and healthy balance sheets will be more attractive amid continued supply-chain disruptions, inflationary pressures, and market volatility.
Continue to seek inflation hedges — We have seen no signs that global commodities companies are planning to ramp up their capital spending and production. Thus, we expect a continued structural supply/demand imbalance that could keep commodity prices elevated and would argue for allocations to commodity equities, inflation-protected bonds, and some real assets.