Following two consecutive quarters of contraction, the US has officially announced a “technical recession”. World economies are fresh off a pandemic, and the recovery has been hindered due to uneven supply and continued disruptions because of geopolitical situations such as the Russia-Ukraine conflict.
In the Continental Group’s latest webinar survey, the respondents wholly agreed that rising inflation will impact their cost of living by at least 10%. Furthermore, about 38% of respondents said inflation will impact their cost of living by more than 20%. In the same webinar, experts attempted to demystify inflation, recession, and their current and potential impact on businesses, economic sectors, and livelihoods.
“The last prominent inflation was in the 70s, the data of which is rather thin and inapplicable to modern-day circumstances. In previous inflationary cycles, the curves were flattened through rate hikes, etc. In today’s case, however, with complex causal factors, the possibility of further steepening cannot be ruled out,” said Joseph Graham CFA, Managing Director & Investment Strategist, Lord Abbett. “Directly, people are witnessing it through higher domestic fuel prices. Indirectly, the impact will be felt through a rise in transportation and food costs, etc. The impact is across the board,” added Atul Penkar, Senior Portfolio Manager, Aditya Birla Sunlife AMC.
Despite noticeable risks of recession, Central Banks continue to remain coy.
So, highlighting the issue, Graham said that yield curves are not the best indicators of recession probabilities. “The recession, if at all, is unlikely to cause widespread job losses or credit defaults. It’ll be more like a victimless crime.”
That said, the impact can be more severe on nations with depleting foreign reserves, mounting debts, and downbeat growth projections. As commodity prices rise during inflation, they offer protection for investors. However, for importing nations, it spells troubles. Economies with higher debt-to-GDP ratios, according to Atul, will be more susceptible to commodity-price shocks. So, where does this situation leave the Middle Eastern economies?
“In the GCC region, increase in oil prices has led to a cash surplus in government revenues, and there are positive signs in local markets. However, because these are importing economies — particularly food imports — inflation is inescapable. And being pegged to the US dollar, they are essentially importing inflation. For investors, the solution hinges on strategic allocation, preferably in consumer staples, healthcare, tech, financials and energy,” said Neelam Verma, Vice President & Head of Investments, The Continental Group. Neelam’s thought on the “pegged currency” connection sets alarm bells ringing in light of the US officially announcing “technical recession.”
Moreover, the non-oil sectors in two of the biggest economies in the Arab world, the UAE and the KSA, continue to be resilient, with employment levels remaining buoyant. As a proactive response, the governments have earmarked sizable monetary support for low-income citizens and stockpiled key commodities. At this juncture, the experts opined, investors should refrain from knee-jerk reactions and instead focus on the long-term view.
While investors are wary of the “stagflation” situation, they continue to remain upbeat, as evident from the survey, where 68% of respondents affirmed their confidence in equity/stock markets. Conversely, the fixed income space found support from 21% of the polled. This can be rationalized by what Joseph Graham said: “Fixed income, especially core portfolios, carry high-rate risks. So, inflation and the naturally accompanying interest rate hikes run counterproductive to fixed income instruments. So, they should be strategically placed in the portfolio. For companies, this also presents a credit risk.”
“The Central Banks have a tough choice between excessive inflation or inducing recession. For the stocks and bond markets, this means that a greater part of the decline has already taken place and that a new rally phase could commence before long. A far greater decline would also be risky from the perspective of Central Banks as many assets serve as collaterals for the loan,” explained Neelam Verma. At the same time, caution should be exercised before exploring portfolio changes for short-term gains from commodities such as energy.
“As we’ve seen, prices can rise rapidly but reversals can happen just as quickly. This is especially true when the cause of the sharp increase is a geopolitical event. This may be a good time to review your portfolio with your financial advisor, as your exposures to particular sectors may have changed dramatically, given recent market movements. Though it may sound counterintuitive, rebalancing your portfolio by selling recent winners — such as energy companies — and buying sectors that have declined may allow you to lock in some gains while ensuring you’re not overexposed to the risk of a commodity price reversal,” Neelam added.