There is a sense that the world is slowly “getting back to normal,” after more than a year of COVID-induced economic lockdowns and other restrictions. Unfortunately, many countries — and even some parts of the US — are still grappling with more contagious and virulent strains of the virus (e.g., the so-called “Delta variant”) and troublingly low COVID vaccination rates. We are not out of the woods yet. But broadly speaking, the global economy has been recovering with the aid of accommodative fiscal and monetary policy, supporting the strong performance of risk assets and the ongoing rotation from growth- to value-oriented exposures.
The threat of rising inflation is a bogeyman now. Amid supply/demand imbalances in labor and other factors, we believe inflationary pressures are likely to persist in the period ahead. Against this backdrop, our investment outlook remains largely pro-risk, but is tempered to some degree by what we see as a worsening growth/inflation trade-off. Here are a few thoughts on how investors might navigate this mixed picture.
Stick with value-oriented equities
In our view, the specter of higher inflation and interest rates favors the potential outperformance of value-style equity exposures going forward (Figure 1), including smaller-cap stocks and more cyclical market sectors such as financials, consumer discretionary, materials, and industrials. From a geographic standpoint, we generally prefer non-US equity markets, particularly Europe, which we believe is on the cusp of an economic upturn. We are moderately bullish on emerging markets, given their leverage to an accelerating global cycle, elevated commodity prices, and continued US-dollar weakness.