Stagflation, reflation, soft landing, or slump?
We analyze each of these potential scenarios, how we might get there, their likelihood, and the market implications.
Equity and bond markets are driven by stories, hopes, and fears about the future path of growth and inflation. The story of the first half of 2022 has been one of “stagflation,” with fears that the Federal Reserve will need to hike rates faster and further to contain inflation driving bond yields higher and equities lower.
The question now is what story will drive the market over the second half of the year: “Stagflation,” “reflation,” “soft landing,” or “slump”? And how will markets react? Now that Fed officials have indicated how closely they are watching and reacting to monthly CPI prints, each inflation data point will likely cause volatility. Yet it will take several months of data, at a minimum, for the market to gain some clarity on what narrative will dominate the second half of 2022. We want to be prepared for that volatility as it presents both risk and opportunity.
In this letter, we analyze each of these potential scenarios, how we might get there, their likelihood, and the market implications. We also map our investment ideas against each scenario.
Four scenarios that could drive the market
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| Current | Current | Soft landing | Soft landing | Slump | Slump | Stagflation | Stagflation | Reflation | Reflation | |
---|---|---|---|---|---|---|---|---|---|---|---|---|
| S&P 500 | S&P 500 | Current | 3,760 | Soft landing | 3,900 | Slump | 3,300 | Stagflation | 3,300 | Reflation | 4,500 |
| 10-year yield | 10-year yield | Current | 3.16% | Soft landing | 3.25% | Slump | 1.5% | Stagflation | 4% | Reflation | 3% |
| Equity risk premium | Equity risk premium | Current | 306bps | Soft landing | 278bps | Slump | 426bps | Stagflation | 312bps | Reflation | 260bps |
| Implied forward P/E | Implied forward P/E | Current | 15.9x | Soft landing | 16.6x | Slump | 17.4x | Stagflation | 14x | Reflation | 17.9x |
| Forward earnings per share | Forward earnings per share | Current | USD 231* | Soft landing | USD 235 | Slump | USD 190 | Stagflation | USD 235 | Reflation | USD 252 |
| Earnings growth (y/y) | Earnings growth (y/y) | Current |
| Soft landing | 3.5% | Slump | -16.3% | Stagflation | 3.5% | Reflation | 11% |
| Probability | Probability | Current |
| Soft landing | 40% | Slump | 30% | Stagflation | 20% | Reflation | 10% |
This is not a market to position for any one scenario with high conviction. As always, our goal is to build a robust portfolio that can help protect and grow wealth under a wide range of scenarios.
In our own portfolios, we use these scenarios to uncover a broader set of investment opportunities across asset classes or structures. This helps us respond with portfolio actions when volatility creates opportunities.
We think investors looking to build a robust portfolio should take the following progressive steps: