Andrew Harmstone
Investment experts from Morgan Stanley Investment Management, the asset management division of Morgan Stanley, Andrew Harmstone and Eric Zhang, share their insights across three current market themes.
1. Rates on the rise
Whilst quantitative tightening puts further upward pressure on US rates, pension fund and foreign demand may limit the upside for nominal rates, as we move past recent highs.
2. The “Real” threat for equities
Despite slower growth in the global economy as stimulus and reopening booms fade, the major equity regions are expected to offer healthy earnings per share (EPS) growth this year, with the IT sector and US equities most at risk from rising real yields, given high valuations and a greater sensitivity to real yields.
3. Omicron may prolong supply chain disruptions
Port congestions and supplier delivery times have improved, causing shipping prices to roll over. However, the impact of the Omicron variant, especially in Asia, may prolong the disruption. This could lead to inflationary pressure from higher shipping costs and continued supply constraints through the first half of 2022.
Andrew Harmstone, Senior Portfolio Manager, Global Multi-Asset and Head of Global Balanced Risk Control, Morgan Stanley Investment Management, said: “There has been growing demand for US Treasuries, and in particular from US pension funds which are shifting their exposure to more fixed income assets as they become fully funded and do not need as much equities in their portfolios. Foreign demand for US Treasuries has also been strong, as the prospect of rising interest rates in other markets, such as Asia, are lower than that of the US.
“When you have a growing environment, growing interest rates, EPS growth is likely to be strong as well. Unfortunately, one of the consequences of strong growth is upward pressure on real yields, and that in turn has a negative impact on equity valuations. What we are also seeing since the end of 2021 is a change in investor willingness to take on risk. The last month has highlighted that equities can be volatile, and it is now changing investors’ risk tolerance.
“With the Omicron variant, supply chain disruptions may last a bit longer than we would hope. Whilst the cost of shipping has started to roll over and reflecting improvements in supply chains, the consumer price index tends to react with a lag, which means the impact on inflation related data is likely to be prolonged. This makes it a difficult environment for central banks not to tighten because of inflationary pressures, which will be visible for some time and creates the risk of rising real rates as central banks respond to the inflation data.
“The investment implication right now is to be a little bit cautious while these issues work their way through and to look for opportunities amid market weakness. It also suggests to have an underweight in duration because of the rising rate environment. Broadly speaking, we want to avoid asset classes that are more exposed to rising real rates and also favor those tend to benefit from that. Obviously, valuations are becoming more important now given the change in investor risk tolerance.”
“Overall, developed markets will likely perform better than emerging markets in the first half of 2022. That is because emerging markets as a whole experienced slower growth in 2021 versus developed markets. The expectation is that emerging markets growth will gradually pick up in 2022, but the pace of that increase is likely to be moderate. Inflation remains a challenge for regions such as Latin America and EMEA, which will put pressure on central banks to tighten. That in turn drags on growth of emerging markets as a whole in the first half of 2022, but if inflation stablises, we may see growth pick up in the second half of the year.”
Eric Zhang, Portfolio Manager, Asia and Head of Tactical Positioning, Global Balanced Risk Control, Morgan Stanley Investment Management, said: “Within emerging markets, we think Asia will do better in 2022. One reason is that restriction measures due to the pandemic have continued to decline, paving the way for gradual reopening and recovery of economies. This is because Asian markets have a larger population that is vaccinated compared to Latin America and EMEA. In addition, Asia has a decent growth backdrop, as governments in the region have the ability to implement policies to support growth where needed.
“As we progress to the latter part of the year and when we pass through the Omicron variant wave, the global economy will continue to recover and that will have varying impact on emerging markets. For example, slowing commodity growth and inflationary pressures are likely to impact emerging markets that are closely linked to commodities, such as Latin America. Asia, on the other hand, tends to be a commodity importer, and the region consists of more diverse sectors, meaning it will likely benefit as the world begins to normalise.”