This article first appeared in Capital, The Edge Malaysia Weekly on September 5, 2022 - September 11, 2022

ANY hope of a dovish shift that drove the stock market rebound in June and July evaporated late last month after US Federal Reserve chair Jerome Powell made it crystal clear at the annual Jackson Hole Economic Symposium that inflation had to come down and concerns about an economic slowdown were not a priority.

Oil and equity prices tumbled on fears that the US central bank’s hawkish approach to tackle inflation would dent the global economy and hurt demand.

Nevertheless, Manulife Investment Management (MIM) reckons that equities are already markedly lower and that investors should capture recovery opportunities over the next 12 to 18 months.

But how exactly are investors supposed to do that amid a tighter monetary policy environment, market uncertainty and volatility?

Paul Kalogirou, managing director and head of client portfolio management team in Asia at MIM, says investors who think there is a high risk of a drawdown in the next five to six months should go for more defensive stocks, global income equities or high-dividend counters.

Those with a higher risk tolerance, meanwhile, may want to consider US high-yield bonds or broad emerging-market-blended corporate high-yield bonds, says Kalogirou, who is also client portfolio manager on MIM’s multi-asset solutions team in the region.

“Certainly, parts of the emerging markets (EMs), from a valuation perspective, are attractive. If you ask me, would I rather invest in US or EM bonds, I would still say the US is more favourable because its default rates are pretty low, while it could offer 6% to 7% yield. Having said that, EM bonds have their place in the market, and if investors are looking for 9% to 10% yield, these are the options out there,” he tells The Edge in a virtual interview.

Hong Kong-based Kalogirou, who has 19 years of financial industry experience, including 15 in Asia, notes that the macroeconomic environment is not necessarily fully correlated with what is going on in the market.

“You could have a very bad macro. But at the same time, you could have a fairly positive market, and obviously, the vice versa of that. In terms of where we are today, the aggressive Fed rate hike profile has somewhat been priced in by the market,” he observes.

He recalls that back in June and July, the global market was fairly upbeat despite the Fed rate expectations being anchored around 3.5% to 3.75%. However, the market has softened following the Jackson Hole conference, not to mention higher-than-expected inflation prints in Europe.

“If we are seeing high inflation prints, then arguably, the Fed has to do a little bit more. And therefore, the market will have to digest the potential of higher Fed rates than what they had expected a few months ago,” Kalogirou cautions.

He reiterates that the Fed is unlikely to soften its rhetoric, and in many ways, the central bank still has to push through the rate hike profile because the US needs to strong-arm inflation.

“Don’t forget we still have the US midterm elections in November. Joe Biden is highly likely to want to be seen as a president who is combating inflation and therefore, he is going to keep pressure on Jerome Powell to continue to bring down the inflation number. Overall, the global equity and debt markets will remain volatile,” he says.

Although certain quarters believe that equities had bottomed in June — some of them even anticipated that the market would end the year higher than it was in May — Kalogirou says MIM, at least from the perspective of its tactical asset allocation portfolio, is of the view that indices will retrace their lows instead.

“So, we are talking about the S&P 500 possibly retesting the 3,700 to 3,800 levels. One of the reasons is because we haven’t really seen a full flush out or a real panic sell-off in the market. Of course, we may be wrong and the day [of massive sell-off] may never come,” he adds.

“But there are still a lot of factors — the Fed language, geopolitics, the US midterm elections — for the market to digest from now until year end, and we’ll see how these events pan out. Overall, we maintain a fairly cautious stance.”

The S&P 500 closed at 3,955 points last Wednesday.

With the ongoing Covid-19 pandemic, Fed rate hike, Russia-Ukraine war and global recession fears, can things get any worse in 2022?

Kalogirou warns that the world may see a further breakdown in geopolitics, such as the relationship between the US and China, as well as that between Russia and Europe. The market, however, will try to look past all of that, so the outlook may not be bad. “One of the threats is that Russia may turn off its commodity supplies to Europe in winter. We are already seeing stress in Europe in terms of the price of gas and electricity. There could be worsening conditions for consumers or the man in the street because their disposable incomes and their families will be affected,” he points out.

While the black swan, bear and hawk have crossed paths in 2022, Kalogirou insists that the recession of the early 2000s, the global financial crisis of 2008/09 and the Covid-19 crisis in 2020 were a lot worse for the markets.

“We saw a much steeper and worse drawdown in the equity markets then. But of course, from a macro perspective, when we look at geopolitics, what Covid-19 has done to growth rates, what the Russia-Ukraine war has done to commodities, and what the decoupling and deglobalisation have done to supply chains, then yes, there have been great impacts on the market,” he acknowledges.

“But if we look at the performance of the S&P 500, we haven’t seen a significant drawdown from the peak. Markets are clearly pricing in a lot of bad news. If we think about how the world looked at Covid-19 in 2020, and how the markets recovered from the lows in March that year, there have been a lot of capital inflows back into the markets,” says Kalogirou, who joined the firm in 2019.

Like it or not, he says, over time, there will be periods when investors experience uncertainties, as these are part of the market cycles. “I am not saying that we are not in an uncertain time, because we certainly are, but there are always pockets of opportunities. If we look at the historical spreads and where the yields are, it may be a good time to buy now, especially for those investors who have a reasonably higher risk appetite.”

Kalogirou suggests that investors start adding incrementally some of the spread assets and risk assets to their portfolio. As for those with a lower risk profile, they should have exposure to higher-quality fixed income or higher-income equities.

Investors who are starting on a clean slate and looking at capital allocation may want to pick up some growth equities whose valuations are distressed. “But if you have already built a portfolio, you may want to look at value-oriented equities that offer attractive dividend yields that could add income to your portfolio,” he says.

“In short, this is how we are approaching it. This is essentially our Manulife Global Multi-Asset Diversified Income Strategy. We are recommending our clients to look at more income-related asset classes, such as dividend stocks, REITs (real estate investment trusts) and traditional fixed-income assets.”

Interestingly, Kalogirou highlights that China has been a challenge as far as the credit market is concerned. Moreover, the country’s property market is under a fair amount of distress.

He observes that China’s zero-Covid policy is impacting its economy, while Chinese developers are facing mortgage boycotts. “For sure, the growth slowdown is evident. The demand for base metals has decreased, and it has been reflected in the lower prices of iron ore and aluminium.”

While MIM’s global multi-asset portfolio has some exposure to credits in China, the firm is relying on its credit analysis team to ensure that there won’t be any defaults in its portfolio.

“We will pick the China credits that we think will survive. At the same time, for those credits that we think the default risk is high, we will diversify out of China but remain in Asian credits, such as those of India and Indonesia, which are more correlated to the US high-yield markets,” says Kalogirou.

“Don’t get me wrong, there are still some good opportunities in China’s credit market, but you will probably be taking a fair amount of risk to get that yield. So, you may want to diversify into other Asian credits.”

He says it is up to individual fund managers to help navigate these risks and reduce the drawdown impact from Asian credit portfolios. MIM is not increasing its exposure to Chinese equities.

“There have been times when we tried to add into the Hong Kong equity market but overall, we are still concerned about China’s zero-Covid policy, how it is impacting the business environment and market sentiment,” says Kalogirou.

Nevertheless, he is quick to state that MIM is not reducing its exposure to Chinese equities because the firm did not invest heavily in the country. “It’s really a neutral decision. It’s not a conviction. It’s not trimming,” he says.

On the home front, MIM’s analysis suggests that Malaysia will be a relative macro-outperformer among other Asia-Pacific economies, alongside Indonesia and Vietnam.

“We continue to believe economies most insulated from the negative demand shock are net food and energy exporters, those less reliant on foreign capital and those that still have policy space. At the same time, economies most capable of mitigating the negative supply shock will have a relatively lower weight for food and energy in their inflation and import baskets,” Kalogirou stresses.

In general, MIM believes that defensive sectors like consumer staples will outperform cyclical ones, such as consumer discretionary and financials, at this point.

Kalogirou urges investors to stay invested in these uncertain times, but stresses that they must be willing to adjust their portfolios towards specific macro backdrops and macro regimes. “We are in high inflation, low growth and tight financial conditions. So, we need to ask ourselves, which asset classes are more relevant in these types of environments?

“In the meantime, we should also be looking at asset classes that will be beneficial when inflation starts to moderate, growth begins to pick up and financial conditions are loosening. There are always portfolios out there that could do all that for you.”

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