Quarterly Asset Allocation - Q2 2022

2Q Investment Outlook: Despite short-term outlook for equities is downgraded, they may generate greater returns than bonds by year-end

Q: Principal Asset Management (Asia) Investment Management Team

A: Crystal Chan, Senior Investment Specialist of Principal Asset Management (Asia)

Q:What is the outlook for the global economy?

A: Global economic outlook is exceptionally uncertain. Due to key uncertainties, global growth projections were adjusted downwards. With the swings in commodity prices, inflation may stay high for a few more months before it starts to subside. The risk of a stagflation is rising. The combination of slow growth, high unemployment, and fast inflation may put significant pressure on the economy.

Q:What are the major uncertainties ahead?

A: While geopolitical risks usually have a short life in terms of market impact, this episode is more complicated. The surge in energy prices in response to the Russia/Ukraine conflict comes at a time of existing tension in energy supplies. If commodity prices stay elevated, it may hit consumption and impact growth more extensively.

According to the March Fed dot plot, there may be a total of seven interest rate hikes in 2022. As the uncertainty clears, there is an opportunity for a more aggressive pace of policy tightening in the second quarter. Quantitative tightening may also kick in soon. Financial conditions might tighten more as policy rates head higher globally.

Q:How should equity assets be allocated in 2Q?

A:All these factors make us downgrade our equity outlook to neutral in the short-term. Among them, we are slightly optimistic about Japan, neutral in the U.S., Asia, China and Hong Kong, while slightly bearish in Europe.

However, despite a deteriorating global growth outlook, equities fundamentals have improved in the past quarter. Except for the U.S., the valuation of global equity has receded to a level closer to 10-year average.

Capital may extend an 18-month trend and continue to flow towards equities. Sentiment may turn more positive on eventual easing geopolitical tensions and oil prices. Negative real rates are likely to support equity performance as well.

Therefore, stocks are still likely to generate greater returns than bonds by the end of the year. From a longer-term investment perspective, investors may consider maintaining a higher proportion of stocks than bonds.

Q:How should bond assets be allocated?

A: For the second quarter, we remain neutral on fixed income overall. Although geo-political risks and other uncertainties may cause a flight towards safety, treasury yields are expected to go higher with higher inflation expectations. We remain slightly bearish on sovereigns. Given the relatively strong health of the corporate sector, further spread widening may be limited going forward. At the same time, the hunt for yield from investors remains strong. Investment-grade is neutral.

Crystal Chan
Senior Investment Specialist
Principal Asset Management (Asia)

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