In this Article
- Major asset classes across global markets have all suffered severe declines this year. Traditional investment portfolios have been battered as bonds have been unable to provide stability.
- As policymakers strive to fight high and rising inflation without sacrificing growth and employment, investors must consider various potential outcomes as they make investment decisions.
- A global macro strategy may be beneficial in uncertain times due to its ability to embrace diverse and less correlated return sources while maintaining the flexibility to take long and short positions.
- A robust risk framework that dynamically adjusts to shifting conditions is key to an effective global macro approach.
Tough Terrain for Traditional Assets in 2022
The first half of the year was brutal. Lingering supply chain issues, exacerbated by the war in Ukraine and pandemic-induced shutdowns in China, helped push global inflation significantly higher. As various central banks tightened monetary policy in response, fears of recession gripped markets. Stocks, bonds and real estate assets across global markets all declined in the first half. The Bloomberg Commodities Index rose 18.4% during that time, led by soaring crude oil and natural gas prices.
Hawkish central banks keep markets on edge
Central banks around the world are enacting restrictive monetary policies to rein in inflation. Their efforts can lead to various outcomes with distinct investment implications. Below are four of the most likely scenarios and resulting potential impacts to equity and bond markets:
While the probability of a "hard landing" could be higher than expected, recent comments by policymakers suggest that the likelihood of a "soft landing" and/or a scenario in which the Fed pauses as it decides to tolerate higher inflation is rising. Of course, nuances, including timing and messaging related to monetary policy, can set off other scenarios. Geopolitical matters, such as the war in Ukraine, hold power to influence global economic conditions as well. Past experience tells us that markets can recover once the worst of a slowdown can be reasonably assessed in tangible terms, but they rarely recover while policymakers still convey an outwardly hawkish posture.
Global macro can flexibly bolster a portfolio’s resilience
Declines in major asset classes, higher interest rates and a lack of visibility regarding the near-term fate of the global economy pose challenges to the traditional 60/40 portfolio model. Historically, bond exposure has provided ballast during equity downturns, but recent declines in bonds have been substantial, with some of the largest drawdowns seen since 1990. Yields across the curve surged higher, dragging prices down and offering little defense for the traditional portfolio.
An agile global macro strategy can isolate diverse and less correlated sources of returns by factoring in regime shifts and profound changes in sentiment or expectations. The ability to go both long and short in various asset classes is an additional advantage, providing flexibility to react nimbly as conditions shift. Global macro generated a +9% return this year through June versus a -19% return for a 60/40 portfolio consisting of the S&P 500 and Bloomberg U.S. Aggregate Bond Indexes. Outperformance of this magnitude (28% in this case) could provide meaningful resilience to diversified portfolios during times of severe market stress.
A NIMBLE STRATEGY FOR FUTURE VOLATILITY
If the first part of 2022 is any indication of what is to come, volatility should be a prominent market characteristic for the foreseeable future. Our team is closely monitoring the data to see which economic scenario seems more likely to prevail. We are also watching policymakers closely to assess their resolve to tighten and modelling how the timing of a possible recession might impact asset prices.
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