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Market Monitor: The War on Stagflation

  • We believe the world is entering stagflation where high inflation exists alongside low growth and high unemployment

  • Hostility between the West and Russia/China will continue for years, if not decades

  • We were not convinced that we were heading for a global recession until Russia’s invasion of Ukraine...

Warut Promboon
Warut Promboon

Managing Partner - Credit Research

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Bondcritic
2 April 2022
Published byBondcritic

It has been 2 years since we cautioned our readers on the Good, the Bad, and the Ugly of COVID-19. The market has improved a bit on the vaccine discovery in late November 2020 but has not improved much, in our view, on persistent mutation of the virus. We were not convinced that we were heading for a global recession until Russia’s invasion of Ukraine.

Inflation started last year with the supply chain problems as the world seemed to get used to living with COVID-19. The war came in at the right time to boost inflation further on rising commodity prices. We believe even if the war may end this year, hostility between the West and Russia/China will continue for years, if not decades. In addition to arms races, we believe the stand-off will lead to inefficient production and rising cost of production in general.

With the combination of low interest rates and a lack of investment opportunities, we believe the world is entering stagflation where high inflation exists alongside low growth and high unemployment. This will be a dilemma for the world’s central banks to stimulate the economy, as rate hikes will stun growth but persistently low rates will allow inflation to rise even higher. To make matters worse, global rates have been kept artificially low since the Lehman crisis in 2008 and we believe governments will need to use more fiscal policies to spur production. In our view, the past period of low rates and quantitative easing has created a period of easy money where inefficient enterprises are kept alive instead of letting the economic cycle turn. For the latter, we believe defaults have been kept artificially low for years and now is the time that we will start seeing the reality of a bust cycle taking place.

That said, we see the New Normal as the New Abysmal for global economic growth. A volatile and uncertain market will keep investors in the short-term corporate bonds, especially the cross-over credit rating sector (i.e. BBB-/BB+). Rising defaults will bring buying opportunities for those who do homework. For equity investments in the near term, we prefer defensive industries such as utilities, food, agriculture, healthcare, and consumer non-discretionary. We also prefer renewable energy on a continued focus on fighting climate change.