June market outlook: Will the stagflation trade last?

As the share market begins to enter a somewhat bearish environment worldwide, ClearView Chief Investment Officer (CIO) Justin McLaughlin believes that heat could be about to come out of cyclical commodities investments that have so far performed well in 2022.

So far in 2022, share markets have begun a gradual decline many believed was inevitable off the back of soaring inflation and the intention of many central banks to raise interest rates.

Cyclical stocks have held up mainly due to speculation around commodities shortages because of the Ukraine invasion, but in his most recent CIO Insights webinar, ClearView’s Justin McLaughlin said he believes this trend was not likely to continue much longer.

“We have a series of conditions one would expect in a normal risk-off environment – over-valuation, rising interest rates, rising inflation, an increased risk of recession and central banks behind the curve and unable to support the market,” Mr McLaughlin said.

“Until recently, investors have also been playing the ‘stagflation trade’ and crowding into low quality cyclicals, because in the 1970s commodities were a good hedge against inflation. But when you go into a recession you want to be in the safest assets possible – you don’t want to be in cyclical assets because if the economy weakens, these are likely quite vulnerable.”

Mr McLaughlin said the likelihood of a recession in both the US and Europe was climbing, due to the Ukraine war and declining consumer confidence in the US.

“At the moment the US consumer is as depressed as they were in 2008, which is astonishing because we are at fuller levels of employment and things are supposedly much better,” he said.

“They are being hit pretty hard by inflation, so consumer assessments of their current circumstances are at recession-style levels although they are not in a recession.”

Mr McLaughlin said that “big swings” in cyclical, commodities and currency-linked investments were likely in the coming months as the share market appears to turn towards a more bearish environment.

“Commodities will likely not be a good stagflation trade - the reason for that is China is key to setting commodity prices and China is slowing sharply,” he said.

“Relative to last year they are selling 50% less apartments than they did in the past. From our perspective the property sector in China consumes 40% of all steel, and if that sector is down steel demand and iron or demand are going to be down.

“With a slowing US, Europe on the verge of recession and China slowing, it points to risks in owning cyclical commodities investments.”

Mr McLaughlin said the outlook was for further interest rate rises and negative impacts on the share market for the rest of 2022, with US President Biden having indicated his priority was dampening inflation over economic growth.

“Central banks are likely going to keep tightening in the next 6 months, and they are not going to worry about the share market as the focus would likely be on inflation,” he said.

“This bear market is going to take time - there are going to be some big rallies and some big falls, but [the market] is ultimately going to head a bit lower.”