A Bumpy Road to a Familiar Low-growth Destination
PGIM Fixed Income explains why it expects to see secular factors overtake cyclical trends as already-building headwinds slow the global economy.
Investors rode a roller coaster during the first half of 2022, with extraordinary events presenting significant challenges. Surging inflation from the ongoing war in Ukraine and renewed COVID-19 lockdowns in China continue to cloud the outlook for global economies, financial markets, and central bank monetary policies. Against this confusing backdrop, our PGIM asset managers assess the current landscape, share perspectives on key trends set to shape the second half of 2022 and beyond, and offer ideas for investors seeking to capitalize on the opportunities ahead.
Global inflation remains elevated despite the consensus view that the worst may be behind us. While goods prices show signs of moderating, service sector inflation continues a steady rise. Developed market inflation also remains high due to the spike in oil and food costs. High and persistent inflation, the longer it remains, risks becoming embedded in inflation expectations, fueling demand for wage increases, and becoming a self-fulfilling prophecy.
The Fed and other major central banks are focused on tightening monetary policy to tame inflation, which surged beyond their earlier expectations. The ECB confirmed that it would conclude net asset purchases by July 1 and start its rate hike cycle at its July meeting. The Bank of Japan remains an exception, making no changes to its current policy stance and framework yet. Central banks in EM continue to raise rates, as most are facing inflation above their target range.
While a multitude of risks remain, equity markets are already pricing in a high risk of recession with many markets experiencing drawdowns of more than 20%. While stocks could fall further on concerns over the Russia-Ukraine war, persistent inflation, and COVID lockdowns in China, the Chicago Board Options Exchange Volatility Index is already at historically elevated levels. Given improved stock market valuations and low odds of an imminent U.S. recession, stocks could experience a powerful relief rally from here.
While we are resisting becoming increasingly bearish on stocks in the context of market declines, we are still pursuing a fairly cautious investment strategy. We are neutral on stocks in our multi-asset portfolios, while overweighting commodities and cash and underweighting fixed income. The outlook for fixed income returns looking forward has improved significantly on notably higher yields on 10-year U.S. Treasury notes and wider spreads on fixed income risk assets. We are considering increased exposure here.
Risks—Investing involves risks. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas. Investments in growth stocks may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated. It may take a substantial period of time to realize a gain on an investment in a small or midsized company, if any gain is realized at all. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved. Diversification and asset allocation do not guarantee profit or protect against loss. Investments in in Master Limited Partnerships (MLP) and MLP-related investments are subject to complicated and in some cases unsettled accounting, tax, and valuation issues, as well as risks related to limited control and limited rights to vote, potential conflicts of interest, cash flow, dilution, and limited liquidity and risks related to the general partner’s right to force sales at undesirable times or prices. MLPs are also subject to risks relating to their complex tax structure, including losing its tax status as a partnership, resulting in a reduction in the value of the MLP investment. Many MLP investments are in the energy sector and subject to a greater degree to risk of loss as a result of adverse economic, business, regulatory, environmental, or other developments affecting industries within that sector than investments more diversified across different industries. Diversification and asset allocation do not guarantee profit or protect against loss.
The views expressed herein are those of investment professionals at PGIM Fixed Income, Jennison Associates LLC (“Jennison”), PGIM Quantitative Solutions, PGIM Real Estate, PGIM Custom Harvest, and PGIM Investments at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale
of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice. PGIM Investments LLC is a registered investment advisor with the U.S. Securities and Exchange Commission. PGIM Custom Harvest does not provide tax, legal, or accounting advice. This material is for information purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation. Clients seeking information regarding their particular investment needs should contact their financial professional.
Prudential Investment Management Services LLC is a Prudential Financial company and FINRA member firm. Jennison Associates, PGIM Custom Harvest, and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. PGIM Quantitative Solutions is the primary business name of PGIM Quantitative Solutions LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2023 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM, and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.
1062090-00001-00 Ed: 09/2022
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