Quarterly Market Outlook: Q3 2022

The first half of this year has delivered a number of adverse shocks that dramatically raised inflation while significantly weighing on growth.

We believe that volatility and uncertainty will remain high until there is an inflection point in the rising path of inflation. Until then, investors will be questioning whether the increase in interest rates that central banks have implemented thus far is sufficient to control inflation. The risk is that by tightening policy aggressively even as growth is threatened by the conflict, central banks could trigger a recession. The credibility of central banks is at stake as inflation at 40-year highs poses the toughest of policy challenges.

As uncertainty about interest rates and growth persists, we believe it makes sense to maintain portfolios with moderate levels of risk focused on quality: profitable companies with strong cash flow generation, low debt and liquidity needs and high and stable margins. Diversification in real assets (commodities, direct real estate, etc.), private markets, capital protection structured products and absolute return strategies will be key in this complex investment environment.

01. Tackling inflation is the #1 priority

Fixed income markets have made a profound adjustment to incorporate a new scenario in which monetary conditions have ceased to be ultraloose. Still, inflation numbers keep on showing higher readings, and this is introducing a new factor of uncertainty: the market is wondering about the level of demand that needs to be removed to ease price pressures. We believe that inflation data should start to moderate in the coming quarters as key base effects are removed, but this scenario has points of fragility that may lead to a scenario of interest rate hikes beyond market estimates. Central banks stake their credibility in this complex environment as they face dilemmas in meeting conflicting targets.

Inflation is forcing central banks to push rates above the neutral rate to moderate excessive demand pushing prices up

02. Crack in the growth outlook

The deterioration in leading indicators is becoming widespread and the high levels of growth expected at the beginning of the year are starting to fade to levels that open the debate of a potential recession in the next twelve months. The continuity of the economic cycle will depend on the level of monetary tightening and the level of deterioration in consumer and business confidence. We analyze several sources of fragility that could trigger a scenario of greater economic slowdown: energy shortages in Europe, gridlock and financial conditions in the United States and the crisis in the real estate market in China.

The deterioration in consumer confidence has been surprising in its speed and magnitude

03. Defensive bias and diversification

Rising inflation poses a major challenge for asset allocation as it negatively affects both bonds and equities. Risk management is key in this environment of macro and geopolitical uncertainty until the scenario about interest rates and growth becomes clearer. We would suggest maintaining portfolios with a low-risk budget, diversification in real assets (commodities and real estate) and alternative investments, focus on balance sheet quality and resilient dividends and cashflows in company selection, and risk management via structured products and absolute return strategies.

Annual returns of a US$ investor in equities (S&P500) and fixed income (U.S. Treasuries)

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