Foresight May 2022: macro themes and market outlook
The world is a different place than it was even three months ago: Cautious optimism around normalization during the second half of the year has long since been clouded over by the fog of war. Another wave of COVID-19-induced lockdowns in China has also washed over supply chains the world over. Where do we go from here? While there are several unknowns, we do have growing confidence in the underlying themes that should continue to dominate the next several months.
Policy pivots will come
At present, market participants and pundits are aggressively trying to out-hawk one another: In the United States, market-implied probabilities have factored in almost 10 additional rate hikes over the next year; Canada isn’t far off that mark either. While Europe and the United Kingdom aren’t being priced as aggressively, the nearly 6 hikes factored into that region are a far cry from the unchanged rates expected as recently as last fall.1
We believe that markets will start to adjust their expectations and price out some of these moves by the autumn. Specifically, we expect that the warning bells rung by the Bank of England, which effectively signaled concern over the United Kingdom’s growth outlook, are likely to echo across other regions. In essence, while the inflationary outlook is far from certain, there could come a point at which it’s no longer by far the dominating concern as it is now; instead, concerns about growth will once again factor into central bank decision-making.
In our view, any sign that inflation is moving toward an acceptable level will be used as cover to avert too bumpy a landing.
In most parts of the world, one key theme that will likely concern markets and central banks alike is declining consumer confidence, which has been shaken as higher interest rates and rising prices have eroded spending power. While employment isn’t a point of concern at this stage, market volatility could be. Investors should note that there are regional flavors to account for as well: In the United States, inventory overshoots in some areas (even as shortages continue to materialize in others) could add to the overall sense of uncertainty, while in Canada, a levered consumer and booming housing market will only serve to make the tightrope that the Bank of Canada (BoC) has to walk even more precarious—an overly aggressive hiking sequence could lead to material consequences. Europe’s proximity to Ukraine and its dependence on Russian energy could be a material disruption to both prices and production activities, which has previously been counted on as a key driver in the continent’s postpandemic recovery—Germany seems particularly at risk here.
Five-year asset class forecasts—expected return components (%)
Inflation: from COVID-19 driven to conflict driven
As we’ve mentioned previously, the narrative around inflation has evolved in recent months. While it used to center on pandemic-related supply chain distortions, discussions are now focused on the potential fallout from the Russia-Ukraine conflict. The former looked set to unwind over the second half of the year and gave us an added measure of conviction that the U.S. Federal Reserve (Fed)—and other central banks—will have the flexibility they need to comfortably slow their pace of tightening. Unfortunately, the war has placed additional upward pressure on prices. Worryingly, the region’s production focus is affecting specific areas of consumer demand (food and energy) that aren’t, academically speaking, considered part of core inflation but are paradoxically core to the consumer, and therefore relatively inelastic. Consequently, as a bigger chunk of the consumer’s disposable income is spent on food and energy, less will be available for discretionary items. The rising interest-rate environment that we’re going into will almost certainly exacerbate the situation and could lead to slowing growth as the adjustment is fully absorbed.
Tactical perspectives
(6–12 months)
Strategic perspectives
(3–5 years)
Equities
Market sentiment has tumbled in recent months as uncertainty soared and volatility spiked—U.S. equities haven’t been spared. Proponents of the asset class are right to note that valuations have contracted to the point where they’re almost in line with historical averages and that the United States remains the developed market with the most attractive growth profile. Even so, we believe that concerns about a slowdown over the second half of the year and tightening financial conditions justify a more cautious stance that’s closer to a neutral or underweight position on a tactical basis. On a structural basis, the United States has the healthiest long-term economic profile in the developed world; however, relative valuation and an expected depreciation in the greenback, particularly against other key developed-market currencies over the longer term, remain headwinds to the asset class.
The Canadian equity market’s exposure to commodities, whose prices are markedly higher than six months ago, provides attractive upside, making it an appealing asset class on a shorter-term basis. Despite a more modest long-term growth profile relative to the United States, we continue to find Canadian equities attractive because of their supportive dividend profile and reasonable valuations. From a currency perspective, an appreciating Canadian dollar could provide attractive short- and long-term support to the asset class.
In our view, visibility around European equities remains shrouded by the fog of war. Valuations remain attractive relative to U.S. equities—risks around disruptions that are directly related to the conflict and the secondary effects of these dynamics fully justify the discount. In the intermediate term, we fully expect that any significant reduction in geopolitical risk, a resumption of the post-COVID-19 recovery, and ongoing fiscal support will lead to a period of outperformance. That said, there’s no evidence to suggest we could get there quickly. Longer term, the asset class offers an attractive dividend profile and a stronger euro would enhance its appeal; however, the region’s weak structural growth profile remains a meaningful offset to those tailwinds, thereby justifying a neutral stance.
This asset class is levered to manufacturing and global trade impulse, which remain constrained by supply chain disruptions. Meanwhile, ongoing economic uncertainty in China, which represents a large part of the emerging-market (EM) equities universe, is also a concern, as are political issues in Brazil. All things considered, we believe a near-term neutral stance is warranted; however, evidence of improved supply chain dynamics and stabilizing global growth could materially improve the outlook for EM equities, especially in view of current valuations. We continue to believe that EM equities remain appealing from a strategic perspective. Valuations remain inexpensive, and the asset class’s growth and dividend profiles are attractive over our five-year forecast period. A structurally weaker U.S. dollar (USD) would also provide a modest tailwind to this asset class.
Japanese equities should in theory provide an intriguing opportunity to investors: Any stabilization in global growth, the yen’s sizable depreciation so far this year, and continued massive monetary and fiscal support could provide upside to the asset class. We believe investors should be on the lookout for any evidence that the aforementioned factors have begun to drive performance. Structural factors in favor of Japanese equities include inexpensive valuation, a possible appreciation in the yen, continued improvement in corporate governance, and generous share buyback programs. Unfortunately, these factors are offset by Japan’s anemic growth profile. From a three- to five-year perspective, we continue to have a neutral view of the asset class, albeit with a slightly positive bias.
Chinese equities underperformed in recent months as a result of deteriorating growth prospects. In our view, any signs that Beijing could be taking a step back from reforms that could undermine market sentiment, a relaxation of current COVID-zero policy, evidence that the current wave of coronavirus infection is flattening out, or a reacceleration in the global inventory cycle could lead to a period of outperformance. We’ve long maintained that Chinese growth will need to decelerate to enable the economy to rebalance from an industrial growth model to a more consumption-led model. We also expect the renminbi to depreciate modestly over the next three to five years. As such, we remain neutral on the asset class.
Fixed income
A combination of high inflation and full employment has led the Fed to adopt a drastically different approach to monetary policy in the past few months, fully justifying an underweight stance in the U.S. fixed-income space. That said, we believe that market pricing of expected rate hikes is overdone, particularly against a backdrop characterized by—as we expect—slowing growth and some moderation in inflation, which could convince the Fed to make a dovish pivot in the second half of the year. Given that the asset class has just undergone a historic period of underperformance, we could experience a temporary reprieve in the coming months, which would justify a smaller underweight than we would previously have advocated for in the near term. Longer term, although the balance of risks has tilted more toward balanced, we maintain that the return profile for this asset class remains weak, especially when compared with other income-producing asset classes such as credit.
As with the United States, we believe that the BoC’s policy stance toward tightening is overly aggressive, especially since the balancing act the central bank needs to perform is arguably more delicate because it must take into account the high level of consumer leverage and long-standing concerns over the country’s residential real estate market. Our views on Canadian government bonds aren’t too different from our take on U.S. Treasuries: The asset class’s negative performance in the past few months and expectations that the BoC could make a dovish pivot in the second half of the year justify a smaller underweight stance than would’ve been the case otherwise in the short term. Over the longer term, the same arguments we used for U.S. fixed income also apply, albeit with one important exception: An appreciating Canadian dollar—which we expect will happen on a structural basis—will mean a slightly more attractive return profile (relative to U.S. Treasuries) for both Canadian sovereign debt and credit.
Although the European Central Bank has turned relatively hawkish recently, we expect European and Japanese interest rates to continue to lag relative to the United States. In our view, normalization will inevitably push European and Japanese rates higher, particularly at the longer end, which will likely translate into headwinds in both bond markets. Crucially, on a currency-adjusted basis, we find Japanese fixed income slightly more attractive than European fixed income. Separately, we expect monetary policy movements in the United Kingdom to foreshadow moves by other major central banks: The Bank of England has already noted its concerns over slowing growth, signaling that while it hasn’t finished tightening, at least a moderation could be forthcoming.
Being structurally overweight in EM debt remains one of our high-conviction views. Over the long term, we think the asset class could provide some of the most attractive expected total returns thanks to the relatively high level of expected income returns it offers—our expectations for a weaker USD over the longer term (five years) are also a contributing factor. Shorter term, we think the asset class continues to provide an attractive yield profile. That said, returns could be hurt by a strong USD and ongoing COVID-19-related disruptions and their overall impact on global growth in the near term.
We maintain our favorable view of U.S. high-yield debt, largely due to the carry that the asset class offers. Spreads relative to U.S. Treasuries have widened somewhat and we’re concerned about the outlook for certain sectors should the economy stall. That said, we expect spreads to tighten should policy uncertainty (as well as inflation levels) recede during the second half of the year, as we expect, providing some incremental upside.
In our view, positive carry from the asset class remains attractive. Moreover, should inflation recede and the Fed pivots as expected, this asset class could benefit from the same dynamics as government bonds on a more short-term basis. While we think that U.S. high-yield debt has a more attractive return profile than investment-grade credit, it’s worth noting that the latter can be used as a tool for investors to add duration to their portfolios. In our view, higher-quality credit can be an attractive alternative to investors seeking refuge from current market volatility.
Alternatives/real assets
U.S. real estate investment trusts (REITs) continue to offer a yield premium over fixed-income assets and attractive diversification benefits, which is appealing in an inflationary environment. In the shorter term, we expect the dispersion across subsectors (as we had mentioned previously) to continue as supply chain issues pause construction and therefore translate into supply-and-demand issues (i.e., raising prices), particularly in the residential and lab/life sciences space. On the other hand, the office sector continues to face headwinds as corporate America adjusts to a new model of flexible working in a postpandemic environment. For this reason, we have a neutral stance both in the short and long term.
With oil prices reaching highs that have only occurred twice in the past 50 years and gas prices also spiking, there’s been considerable price momentum within the energy component of global natural resources. We think the recent swing in price movements is completely normal (within an uptrend) and doesn’t change our view in the short term. While we acknowledge that energy prices, coupled with rising interest rates, will eventually hurt the consumer and lead to a wane in demand, we’re not seeing any signs of this yet going into the driving season in a supply-constrained environment.
In the metals space, while off from late-March highs, we believe gold can continue to fare well over the intermediate term amid the inflationary environment and increased market volatility since the precious metal can offer inflation protection and diversification benefits. We also find other areas of the natural resources space equally compelling. Geopolitical conflicts and the resulting sanctions, for instance, have dramatically reduced the global supply of chemicals, particularly fertilizers, causing prices to rise with little indication of slowing.
Listed infrastructure has become an increasingly interesting asset class that we believe deserves attention from a strategic asset allocation perspective. In our view, the asset class provides an attractive income alternative to what has been a low-yield environment. In addition, infrastructure improvement is a common policy plan within governments across the globe, which should be positive for returns for years to come.
Expected returns table
Developed-market equities: five-year forecast (%)
|
U.S. large cap |
U.S. mid cap |
U.S. small cap |
Canada large cap |
Canada small cap |
EAFE large cap |
EAFE small cap |
Global large cap |
Europe |
Japan |
Income return |
1.3 |
1.2 |
1.2 |
2.5 |
1.7 |
2.9 |
2.5 |
1.8 |
2.9 |
2.3 |
Nominal GDP/growth |
5.9 |
6.5 |
6.5 |
4.9 |
5.5 |
4.2 |
4.6 |
5.4 |
3.6 |
5.9 |
Valuation |
–4.4 |
–0.6 |
–0.2 |
–1.1 |
–0.4 |
–0.7 |
–0.1 |
–3.3 |
–1.0 |
0.3 |
Currency return (vs. USD) |
— |
— |
— |
0.9 |
0.9 |
1.6 |
1.5 |
0.5 |
1.6 |
1.4 |
Total return (USD) |
2.6 |
7.1 |
7.5 |
7.3 |
7.8 |
8.1 |
8.6 |
4.3 |
7.2 |
9.9 |
|
||||||||||
Currency return (vs. CAD) |
–0.9 |
–0.9 |
–0.9 |
— |
— |
0.7 |
0.6 |
–0.4 |
0.7 |
0.5 |
Total return (CAD) |
1.7 |
6.1 |
6.5 |
6.3 |
6.8 |
7.1 |
7.6 |
3.4 |
6.2 |
8.9 |
Emerging-market equities: five-year forecast (%)
|
Emerging |
Emerging Latin America |
Emerging EMEA |
Emerging Asia |
India |
China |
Hong Kong |
Taiwan |
S. Korea |
Singapore |
Income return |
2.4 |
3.8 |
3.3 |
2.1 |
1.1 |
2.2 |
3.0 |
2.6 |
2.1 |
2.9 |
Nominal GDP/growth |
7.3 |
5.6 |
6.0 |
7.7 |
9.4 |
6.7 |
5.4 |
8.5 |
8.4 |
4.5 |
Valuation |
–0.6 |
1.0 |
1.5 |
–0.9 |
–3.0 |
0.1 |
0.8 |
–2.3 |
0.3 |
–1.9 |
Currency return (vs. USD) |
0.3 |
–0.1 |
–1.5 |
0.5 |
0.5 |
0.0 |
— |
0.7 |
1.6 |
2.1 |
Total return (USD) |
9.4 |
10.4 |
9.2 |
9.5 |
7.8 |
9.0 |
9.3 |
9.4 |
12.7 |
7.7 |
|
||||||||||
Currency return (vs. CAD) |
–0.6 |
–1.0 |
–2.4 |
–0.4 |
–0.4 |
–0.9 |
–0.9 |
–0.2 |
0.7 |
1.2 |
Total return (CAD) |
8.4 |
9.4 |
8.2 |
8.5 |
6.8 |
8.0 |
8.3 |
8.4 |
11.7 |
6.7 |
Fixed income: five-year forecast (%)
|
U.S. investment grade |
Canadian investment grade |
U.S. high yield |
U.S. leveraged loans |
U.S. TIPS |
Emerging-market debt |
Asia investment grade |
Global gov’t bond |
Income return |
3.6 |
3.4 |
7.2 |
6.2 |
0.3 |
6.5 |
4.1 |
1.8 |
Price return |
–1.0 |
–0.4 |
–3.1 |
–2.6 |
0.3 |
–0.2 |
–0.5 |
–0.6 |
Currency return (vs. USD) |
— |
0.9 |
— |
— |
— |
0.2 |
0.9 |
1.1 |
Total return (USD) |
2.6 |
3.9 |
4.0 |
3.6 |
0.6 |
6.5 |
4.5 |
2.3 |
|
||||||||
Currency return (vs. CAD) |
–0.9 |
— |
–0.9 |
–0.9 |
–0.9 |
–0.7 |
–0.1 |
0.2 |
Total return (CAD) |
1.7 |
2.9 |
3.1 |
2.7 |
–0.3 |
5.5 |
3.5 |
1.3 |
Alternatives/real assets: five-year forecast (%)
|
U.S. REITs |
Global natural resource equities |
Global listed infrastructure |
|
Income return |
2.9 |
3.4 |
3.5 |
|
Nominal GDP/growth |
2.4 |
4.6 |
4.3 |
|
Valuation |
–2.1 |
–1.0 |
–0.5 |
|
Currency return (vs. USD) |
— |
0.4 |
0.5 |
|
Total return (USD) |
3.1 |
7.4 |
7.8 |
|
|
||||
Currency return (vs. CAD) |
–0.9 |
–0.5 |
–0.4 |
|
Total return (CAD) |
2.2 |
6.4 |
6.8 |
|
1 Bloomberg, May 9, 2022.
Model inputs are factors in Manulife Investment Management research and are not meant as predictions for any particular asset class, mutual fund, or investment vehicle. To initiate the investment process, the multi-asset solutions team formulates five-year, forward-looking risk and return expectations, developed through a variety of quantitative modeling techniques and complemented with qualitative and fundamental insight; assumptions are then adjusted for economic cycles and growth trend rates. The charts shown here may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and are only as current as of the date indicated. There is no assurance that such events will occur, and if they were to occur, the result may be significantly different from that shown here.
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