Consumers have drawn down savings and added debt to fund consumption, and headroom is running out. The winter will see fuel prices hit pockets hard. While at the margin oil and commodity prices are falling, it’s not enough.
Where US housing goes, the global economy goes. The affordability of US housing has collapsed to levels we haven’t seen for decades thanks to soaring mortgage rates, higher house prices and falling real incomes, and we are seeing housing data roll over: home sales are falling fast. It’s not just the US: housing is deteriorating in Canada, Australia, the UK, Sweden, South Korea, among others. Many of these economies have highly levered housing markets, susceptible to higher rates. The impact on housing takes time to come through and will have a big GDP impact. Housing is 20% of US GDP.
A period of slower growth in China is also well understood by investors, but again we’d argue the full impact hasn’t been priced. The unwinding of the China real estate bubble will take years to play out, the zero-Covid policy is stymieing growth, consumer confidence is low, and a sharp slowdown in durable goods spending in developed economies will hit Chinese manufacturing. The government is trapped between high growth targets that look increasingly unattainable and its unwillingness to return to the debt-fuelled infrastructure spending of the past, which makes stimulus difficult. China won’t bail the west out of a recession this time, it will make it worse. There is even reason to believe that China could well be stuck in a liquidity trap as banks are flush with liquidity, yet consumers are reluctant to borrow. A balance sheet recession in China is quite possible. This could well lead to an extended period of secular stagnation.
Against this backdrop, many investors have allowed themselves to hope the Fed will relent, but we don’t think that happens yet; rather, the Fed will continue to tighten, deepening the slowdown. The loss of liquidity from the Fed tapering its asset purchases has historically affected markets as it happens – it doesn’t typically get priced ahead of time – and further Fed rate hikes are probable in September and beyond.
The longer the central banks pursue the end of inflation at the expense of all else, the deeper and more damaging the growth fallout, and hence the recession, becomes. In effect, this approach coils the government bond spring to the extreme and will ensure that the snap back in yields is particularly violent when the pivot arrives.
In the short term therefore, we remain cautiously positioned. Inflation is slowing, but not yet fast enough to allow the Fed to ease policy. The bond markets in our view better reflect reality, anticipating Fed hikes at the short end, and falling growth with lower rates farther out. The difference between 2 year and 10-year interest rates in the US is today the most negative since 2000. We think this curve inversion will deepen, and as recession fears return to markets, bond yields have much further to fall.
We therefore continue to like duration, especially in the US. We like Australia and South Korea government debt, which are vulnerable to China slowing, and have very leveraged housing sectors that are suffering from higher rates. In credit, we own companies in recession-resilient sectors, and special situations that can survive tougher times.
It’s not all bad news for investors: we think inflation will continue to slow because the most effective cure for inflation remains recession. Commodity prices are already helping; over the rest of 2022 goods disinflation will increase significantly as demand slows against a backdrop of excess inventories. As we move into the turn of the year the stickiest component of inflation, shelter, will start to slow quickly as housing deteriorates.
It will be a bumpy ride as growth worsens, but eventually with inflation slowing, central banks will inevitably pivot sharply to much easier policy. This will bring with it a return to “lower for longer,” which is a strong backdrop for fixed income investors; as yields fall, credit markets are backstopped, and duration diversifies risk assets again. This is a once in a generation opportunity to access fixed income markets – but caution is advised in credit markets: you need to know that what you own can make it through a recession.
The value of active minds: independent thinking
Get in touch
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
This document is intended for investment professionals* and is not for the use or benefit of other persons, including retail investors, except in Hong Kong. This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued in the UK by Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited (JAM HK) and has not been reviewed by the Securities and Futures Commission. No part of this document may be reproduced in any manner without the prior permission of JAM/JAMI/JAM HK.
*In Hong Kong, investment professionals refer to Professional Investors as defined under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).and in Singapore, Institutional Investors as defined under Section 304 of the Securities and Futures Act, Chapter 289 of Singapore. 29338