Key highlights

  • The main issue in markets recently has been inflation. But we can break that into three shocks that play important roles.
  • First, is the central bank reaction to inflation. Second is the Russia/Ukraine war, which has led to a surge in commodities prices, which is a stagflationary shock. The third shock has been the zero COVID policy in China, which is also stagflationary but particularly a headwind for growth, as opposed to inflation.
  • The bad news is that these are going to remain headwinds. But the good news is that we think all three are going to get less bad.
  • With the recent drop of the equity markets and the increase in expected inflation which flows through to earnings growth, we’ve increased our mid-term, 5-year return expectations. In the bond markets, we had very low interest rates two years ago, and expected returns were barely positive. As interest rates pop back up, we see the rise of investment grade and cash returns as well.
  • Our inflation expectations have increased to over 3% expected inflation for the next five years. This has severe implications on the stock-bond correlation, which in turn has implications for the risk premia that the markets will demand.

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