Page 10 - ISQ July 2022

INVESTMENT STRATEGY QUARTERLY

Navigating Choppy Markets

J. Michael Gibbs, Managing Director, Equity Portfolio & Technical Strategy
Joey Madere, CFA, Senior Portfolio Analyst, Equity Portfolio & Technical Strategy

Inflation is currently the number one driver of equity mar- FINDING THE BOTTOM
kets. Its stickiness at high levels is weighing on consumer This elevated uncertainty is reflected in market volatility. At its
disposable income and corporate margins, along with recent lows (3,667) the S&P 500, a critical global equity bench-
mark, had pulled back -23.6% from its early January highs. It was
complicating the job of Western central banks as they
not alone, as global developed market equity benchmarks also
attempt to bring inflation under control within a slowing struggled. Whereas enormous fiscal stimulus through the pan-
economic backdrop. demic fuelled lofty valuation multiples, the US and UK central
banks have at last started shrinking their balance sheets and
We believe that inflation has likely peaked (on a year-over-year swiftly hiking interest rates this year has resulting in valuations
basis) and can moderate over the back half of 2022 and into pulling back to more reasonable levels. Plenty of negative news is
2023, as the supply/demand imbalance for goods and labour priced in at prevailing valuations in our view, and the P/E reduc-
normalizes. But the stakes are high, and investors have grown tion is in line with that seen in bear markets historically. Investor
impatient with consecutive hiccups in inflation’s trajectory – sentiment has also become overly bearish, which often takes
i.e., the Delta variant last fall, the Omicron variant, the Russia/ place near lows (contrarian indicator). However, numerous timing
Ukraine war, and China COVID lockdowns. The longer it takes indicators we monitor, along with market internals in the relief
inflation to come to a level that central banks can be more com- rally, have not reached levels often consistent with durable lows.
fortable with, the higher the odds that they may need to Unless the narrative changes in regard to Russia backing off or
overtighten monetary policy (potentially to the point of eco- China ending lockdowns, it will be difficult for equities to sustain-
nomic contraction) in order to bring inflation down. Thus, the ably move to the upside without better inflation data in our view.
degree to which inflation may moderate over the coming While we believe that the market may remain challenged with
months should have a significant influence on the path ahead additional weakness possible in the coming weeks and months,
for the Fed, the Bank of England and the ECB, resulting in a wide we also believe equities will be higher over the next 12 months
range of potential equity market outcomes over the next six to given our belief that inflation moderates as the year progresses.
twelve months.

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