More “Pains” before “Gains”?
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US 1Q GDP growth is -1.6% (qoq saar). The 2Q GDP is not out yet, but the Atlanta Fed GDPNow forecast is currently at -1.2%. This indicates that a technical recession (defined as two consecutive quarters of negative growth) may already be underway. However, there is no imminent risk of a true recession (which requires a broad-based decline in economy activity), as the US job market remains strong (suggested by the non-farm payroll data released last Friday).
Why we stay defensive in the short-term despite significant drawdowns in risk assets?
We won’t be surprised to see a bear market rally given the extreme bearishness. However, we still see another leg down for the market. Potential negatives include:
(1) Significant corporate earnings downgrades as US consensus earnings estimates for 2022 still at high single-digit growth which looks too optimistic
(2) Further widening of high yield spread as highly leveraged companies would be under pressure in coming months amid fast surging borrowing costs and tightening financial conditions; and
(3) Despite very bearish investor sentiment, equity positioning is still heavy. While there has been notable outflows in credit with cumulative flows of investment grade, high yield and EM bonds down over 40% from the 2021 peak, equities barely see any net outflows amid sharp corrections in returns YTD.
What are the potential key positive news in 2H?
A Fed pivot and more clarity after China’s Party Congress are potential positives in the later part of 2H.
(1) A sustain decline in headline inflation, (2) a credit event with systemic threat and/or (3) significant rise in unemployment rate could trigger a Fed pivot.
For China, the 20th Party Congress will announce major leadership changes. More certainty on political and policy directions should benefit Chinese assets.