Global stocks have pulled back from record highs amid renewed Middle East tensions and inflation concerns. There’s a risk of further declines if Middle East tensions escalate and as the market reassesses Fed rate cuts. Nevertheless, geopolitical tensions have generally had a fleeting impact on markets and pullbacks in equities have historically been buying opportunities unless a recession is expected. The Q1 earnings season so far suggests US corporate fundamentals are improving from last year, pushing back recession concerns.
Discipline and diversification are two key principles investors must keep in mind during such uncertain times says analysts at Standard Chartered. In the near term, Developed Market government bonds, where yields are approaching last year’s highs, and the USD could benefit from safe-haven demand if Middle East tensions escalate. For medium-term investors, SC said it sees an opportunity to build or average into a diversified global foundation allocation, especially since it is hard to perfectly time market bottoms. We also see short-term opportunities in select Indian and Chinese assets, among others, amid the ongoing market dislocations.
Middle East flare-up: Initial indications suggest the reported exchange of missiles between Israel and Iran have been symbolic. Major western powers have no interest in seeing an escalation of tensions in the Middle East, which could result in a surge in oil prices and inflation expectations, especially given US and UK elections later this year. As such, the house said it would refrain from over-reacting to headlines and instead use the dislocation to build inflation hedges around our foundation allocation. Top picks among inflation hedges are: US inflation-protected government bonds and energy sector equities. It also sees an upside risk to the gold forecast, which is increasingly driven by geopolitical factors, instead of the traditional drivers such as bond yields.
The primacy of profits: During times of heightened uncertainty, SC said it has historically found it useful to go back to the fundamentals. As the chart above shows, equities typically trend higher as long as the economy avoids a recession. In the case of the US, equity pullbacks have been short-lived in non-recessionary times and have proven to be buying opportunities. Corporate earnings and economic data suggest that the US economy is further away from a recession than envisaged at the start of the year. While these are early days, in the ongoing Q1 earnings season, 86% of the S&P500 companies that have reported so far have beaten earnings estimates. Companies have guided consensus Q1 earnings growth estimates lower to 2.7%, from 5.1% at the start of April. This lowers the bar for beating those estimates in the coming weeks.
Meanwhile, job market and consumption indicators have beaten estimates lately. The continued strength of the US economy, increasingly fuelled by a surge in immigration since last year, is the key driver of a nascent rebound in inflation and pushing back of Fed rate cut expectations. As long as the fundamentals stay healthy, we see equity markets drawdowns as buying opportunities rather than a source of concern.
Discipline and diversification: For medium term investors, instead of following natural instincts of cutting and running, SC said it believes the current dislocations are presenting yet another opportunity to diversify across asset classes and regions. It maintains its diversified foundation allocation, which has a slight tilt towards equities, with US and Japan as our preferred regional markets globally. In Asia ex-Japan, our top picks are India, Korea and Taiwan markets. The month-and-half-long Indian election is likely to keep the incumbent party in power, according to polls. This is likely to be positive for both Indian equities and government bonds. It also continues to see tactical opportunities in China’s non-financial state-owned enterprises.
