Investment Strategy | Volatile Market: Adrian Mowat on the investment strategy for a volatile market

“I’m looking at this turbulence and thinking about what I’m going to buy now, rather than getting caught up in this panic of discomfort that we see when we have these extreme moves. Powell came out and made a very clear statement that they’re going to eliminate inflation and he’s willing to sacrifice the economy, and the market has priced that in,” he says Adrian Mowatmarket strategist.

After global jitters spooked markets, the picture appears to have changed significantly around the world. At least since the interest rate decision by the US Federal Reserve, a hard landing seems to be the baseline scenario for many. Is there any major concern that with weaker stock markets on the anvil, we’ll see a lot more economic pain?
As you said, a hard landing seems to be the consensus now and maybe we should be quite optimistic on that. If you think about the consensus going for the worst possible outcome, that will likely make for pretty good returns over the next 12 months.

The short-term outlook is clearly looking pretty grim as asset markets are breaking through technical levels, the US market is very likely to break its June lows and we have seen some very important currency events. But again, these types of moves in sterling tend to be closer to market bottoms rather than signaling further significant downside.

If you look at the US inflation data, the leading indicators, the inflation numbers that were up early, these data points are now falling. We see a significant drop in transportation costs. If you look at FedEx’s warning, it was very much about the Pacific route, it was very much about the destocking story that’s going on.

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I’m looking at this turbulence and thinking about what I’m going to buy now instead of getting caught up in this panic of discomfort that we see when we have these extreme moves. Powell came out and made a very clear statement that they are going to eliminate inflation and he is willing to sacrifice the economy and the market has priced that in. So what happens when you have a soft landing? Markets will be significantly higher and I think markets are well prepared for bad economic data and a scenario where investors don’t believe the earnings forecasts they are seeing. I could see that the October earnings season was quite good for the markets as companies showed their resilience.

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Finally, I would like to be a little more constructive on the US economy in dollar terms. In nominal dollar terms it is significantly higher than it was at the end of 2019. Companies are a good inflation hedge over the long term as their sales tend to move with nominal GDP and we could have pressure on margins in the short term but if margins normalize then we have a bigger one Return on sales and more profits that result from it. It is a fascinating time and one should not panic.

So you’re saying don’t panic, you’re looking at what to buy given the kind of gloom and doom that’s out there. What could that be?
On some level, I’m looking at some of the tech-enabled large-cap companies in the United States. So Amazon, Google, Facebook or Meta, as they call it now, these are strong companies. Yes, they’ve faced cyclical headwinds like other companies, but they generate huge amounts of free cash flow and look very cheap relative to their history.

So with names like this, you want to be among the blue chips that sell out. Also look at US financials. KEB, the bank ETF, has hit multi-year lows. The underlying business for the financials looks pretty good. Nominal GDP and financial stocks benefit from higher interest rates. All that money sitting in the checking account is starting to generate a return for these banks that they couldn’t generate in a zero interest rate environment. Those are things I look at. So when markets correct, buy liquid large cap blue chip names to manage risk.

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What is the specific view for India, because while we are not completely decoupled from global stock market shocks, on a relative basis India has been much more resilient than the US and also some of the other emerging markets?
India’s outperformance makes a lot of sense in general. We are in a world where people are worried about the US hard landing and we have an Indian economy that may go along with 7% to 8% GDP growth this year. Yes, it will slow down next year, but it looks very resilient in a world where there is a major lack of growth.

It is particularly important to look at India in the context of EM. They don’t want to be in Korea and Taiwan right now because they’re seen as tech cyclicals and China is struggling with its zero-Covid policy and problems in its real estate market. India’s outperformance makes fundamental sense.

Looking for red flags in India, let’s look at the balance of payments until we start to see more pressure on the Indian rupee, perhaps forcing the RBI to raise rates faster than necessary given the underlying rate of inflation India considered. But when I look at the movement of the rupee, it looks modest compared to what I see in the yen or sterling.

In the past we have seen that there is nothing called decoupling. At what point will this realization dawn on us as now India is the fifth largest economy in the world and is among the top ten markets in terms of market capitalization? When will the whole theory of decoupling be swapped out for recoupling?
I would suggest that the global capital markets economies are interconnected, but within capital markets there is a dispersion of performance. So there is nothing unusual about India having better fundamentals and then outperforming. It basically makes sense from a dispersion point of view.

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In this environment, what should be the best tool to protect capital – cash, equities or oversold bonds?
Let’s look at this in two ways. If we’re worried about further downside, then dollars or cash is the only asset class that works. The question is, do you have gyration, do you have the ability to see through current volatility? If you’re ready, what asset classes look attractive right now? I would argue that if the market consensus is that we are in for a hard landing in the United States, US bond yields are still below 4%. In my opinion US bonds are oversold at the long end and that would be attractive.

I would be looking for a job in Europe. The euro was sold off dramatically. There are European exporters that are very cheap and will benefit from a more competitive currency, and in emerging markets it will be interesting as we head into Congress in China in October. There seems to be a lot of pressure building on the Chinese government to become more pragmatic on the economy and perhaps we will see a move away from the zero Covid policy.

It’s probably not explicit, just implicit in terms of loosening etc., and perhaps Hong Kong goes ahead by abandoning hotel quarantine and implicitly accepting the fact that we have to live with the virus. It’s endemic. Chinese assets could be very interesting at the beginning of 2023. So there is a lot of stuff on the buy list as it should be after such a big sell off in the markets.

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