The world economy is showing signs of a rapid downtrend as it contends with tightening monetary policy and thus the likelihood of another global recession and the risk of major financial disruptions. The US Federal Reserve (“the Fed”) will continue tightening monetary conditions, creating challenges for Asian economies, asset prices and currencies in the near term, but the turning point could be approaching when the Fed’s tightening reaches its peak, after which the pressures on emerging economies in Asia should ease.
There are signs that US activities are slowing in response to the tight money conditions. Average hourly earnings are decelerating and job openings have started to decline. Companies like Micron, Nike and Federal Express started having issues of higher-than-normal inventories, slowing demand and price discounting.
We should expect asset valuations to adjust into a new era of higher interest rates and tighter money and it is happening now. We shall watch the corporate earnings in the next two quarters for clues from the year-long policy tightening stance so far. We believe the economic damage from higher rates plus a stronger US Dollar could bring earnings down from current expectations. Forecasts have already dropped across sectors, and further downgrades could be on the way. We are of the view that if there were to be a recession in US, it should not cause a systemic risk like the one in 2008, as the banking system remains strong.
On the UK front, the government has pledged unlimited purchases of long-dated UK government bonds. We believe this should at least put to rest the risk of a contagion in the financial markets for the time being. However, this would add to the global economic weakness in the near term.
On the political front, the Russian-Ukraine conflict continues to deepen, with President Putin declaring that Russia will mobilise additional reservists, annexed the Russian-occupied Ukraine region and reiterated that Russia will use “all weapons systems” available to defend its territories. The situation remains fluid, and we are unsure how this event will pan out eventually. Our best guess is that going into the winter season, the Europeans may like to see an end to this war event by deciding to strike a deal with Russia of some sort, as they were the main collateral damage economically from this conflict.
In a widening US-Sino technology war, the US broadened its current export curbs to include advanced chips and chip-making equipment produced by US companies. China, for its part, is intensifying efforts to expand the capabilities of its semiconductor sector. This will just raise tensions for these two largest economies of the world.
China kicks off its 20th National Congress in October while the US will be holding its midterm elections in November. At a time when US-China relations continue to tread water, these political events will be scrutinized for any hint on the future trajectory of bilateral ties. The heightened geopolitical tension points to a world where both the US and China will aim to be less reliant on each other in terms of trade and technology.
In summary, the global markets appear to be clouded with lots of risk, but as the market trended lower, we see more investment opportunities emerging, especially with tentative signs of inflation pressure easing. We are also seeing governments in some parts of the world being proactive in shoring up the economy or markets at any sign of stress. It goes a long way in allaying our fears that a messy decline like the one in 2008 would take place. We have positioned our portfolio in companies that are well placed to take advantage of an environment when inflationary pressure is easing and monetary policy would likely have peaked, and also to enjoy the eventual recovery when the headwinds progressively subside.