• Stocks and bonds are starting to go on sale. Global and US S&P500 equity indices are down 18-19% from January’s peak, and our preferred bond markets are offering yields above 5%.
• Our equity market sentiment index is showing fear (usually a contrarian signal), and technical indicators are still searching for a bottom. How should investors navigate such markets?
• The first challenge in such an environment is to overcome what is known as the negativity bias – the tendency to attach a higher weight to negative news. Selling assets after a significant sell-off is
  never a good idea as it is rare for investors to be able to correctly time their re-entry.
• For longer-term investors with cash in reserve, we believe it is time to gradually drip feed into increasingly undervalued assets.

INVESTMENT STRATEGY

Beware of negativity bias

• Stocks and bonds are starting to go on sale. Global and US S&P500 equity indices are down 18-19% from January’s peak, and our preferred bond markets are offering yields above 5%. Our equity market sentiment index is showing fear (usually a contrarian signal), and technical indicators are still searching for a bottom. How should investors navigate such markets?

• The first challenge in such an environment is to overcome what is known as the negativity bias – the tendency to attach a higher weight to negative news. Selling assets after a significant sell-off is never a good idea as it is rare for investors to be able to correctly time their re-entry. History suggests that, after major market dislocations, the best course is to stay invested and rebalance to ensure allocations are adequately diversified. For longer-term investors with cash in reserve, we believe it is time to gradually drip feed into increasingly undervalued assets.

• The fundamental backdrop remains reasonably healthy, with the Q1 corporate earnings season in both the US and Europe delivering positive surprises. Our indicators point to a low risk of a US recession in the next 6-12 months. The Russia-Ukraine conflict has not spilled beyond Ukraine’s borders. China’s latest COVID wave is peaking, with relaxation of lockdowns and further stimulus now likely a matter of time. Credit growth is accelerating as authorities jumpstart infrastructure spending to lift growth (loan rate decision and investment data next week).

• We have highlighted in recent weeks the need to see a peak in US inflation and interest rate expectations before risk assets bottom. This week saw tentative signs of stabilisation – the US 10-year government bond yield pulled back after hitting 3.20%, just below the major technical resistance of 3.26% (2018 high). The pullback in yields is starting to break this year’s unusually high stock-bond correlation – bonds rose this week, while stocks fell – that had made asset diversification challenging. Also, US inflation data, while higher than consensus estimates, showed tentative signs of peaking, with goods inflation topping out. US headline inflation slowed to 8.3% y/y in April, down from March’s 40-year high of 8.5%. Core inflation slowed to 6.2% from 6.5%. Categories in the US consumer inflation basket that accelerated has declined to 60% in April from a high of 85% in February. An indicator of US inflation published by the Cleveland Fed that trims out the extreme numbers to focus on the mean consumer inflation has been moderating since October – it continued to decelerate to a 5.5% annualised rate.

• Moreover, oil and gas prices, the main drivers of global inflation this year, have fallen from peaks. It looks increasingly unlikely that the EU will be able to completely ban Russian gas imports. In fact, Hungary is threatening to veto any ban on oil imports, which is less critical for the EU. The pullback in oil and gas prices has resulted in a sharp drop in US 10-year inflation expectations, as derived from inflation-protected securities, to 2.6%, down from a record high of 3.1% in late-April.

• Meanwhile, the US labour market remains strong, with job creation in April beating estimates. We expect normalisation of economic activity to accelerate the shift of US consumption from goods to services (watch retail sales data for April next week). High mortgage rates have barely dented the residential construction market, another driver of growth (April housing starts and building permits data are due next week).

• Against this fundamentally constructive backdrop, several equity and higher-yielding bond markets look attractive. Developed Market (DM) High Yield (HY) corporate bonds and Emerging Market (EM) and Asia USD bonds are once again offering 5-8% yields. Although short-term equity market technicals remain weak, risk takers have a chance to pick up Asia ex-Japan equities at a 20% P/E discount to global markets. We would gradually scale in investments as the market seeks a technical bottom. In China, we maintain a preference towards sectors that stand to benefit from an infrastructure-driven recovery: industrials and financials. European industrials are also likely to benefit from China’s infrastructure spending and from the region’s own shift towards green energy. The energy sector remains preferred in China, Europe and the US. For risk-averse investors, the healthcare sector in the US and Europe offers a relatively defensive option.