Global equities: Three different scenarios and their probabilities

Pendal

October 2022

THE December quarter may see a rally, but equities will be range bound for the next few years, with rotations between value and growth stocks, argues Pendal global equities fund manager Chris Lees.

"Our base-case scenario is that this interest rate shock-crisis 'valuation' bear market is morphing into a recessionary 'profits' bear market, with the S&P 500 already down 25% year-to-date.

"But we don't expect widespread financial contagion, where markets would fall by more than 50% like in 2008.

"Our current scenario analysis is 50% bullish and 50% bearish," says Lees, who co-manages Pendal Global Select Fund with long-time colleague Nudgem Richyal.

"Short-term reasons to be bearish include a recession potentially becoming a financial crisis or contagion.

"Medium-term reasons to be bullish include the US Federal Reserve regaining credibility with inflation and interest rates stabilising next year," Lees says.

Lees breaks down the probability of three scenarios as follows:

• Bullish scenario #1 (15 per cent): Equity markets rally, led by cyclical value stocks. In this case it is probably nearer the beginning of the bear market for those stocks, because any future downturn, or recession, is likely to hit their earnings the hardest.
   
• Bullish scenario #2 (35 per cent probability): Equity markets rally, led by quality growth stocks. That means economically resilient, quality growth stocks are nearer the end, than the beginning, of their bear market.
   
• Bearish scenario (50 per cent): Equity markets keep falling if recession becomes a financial crisis or contagion and policy makers do not react.

What does it mean for investing?

In recent months the fund has sold economically cyclical stocks with earnings risk due to recession, and purchased more economically resilient companies, including some in the emerging markets of Brazil and Indonesia.

"Not many people know that the Brazilian and Indonesian equity markets have outperformed the USA stock market this year - even in US dollars - which is another example of just how different this bear market is from previous bear markets when they fell much harder," Lees says.

The fund is also considering, or as Lees puts it "tiptoeing" around, neighbourhoods where they see positive relative fundamentals and valuations, with stabilising relative share prices.

"Some quality growth stocks are already down 50 per cent year to date and are beginning to stabilise," Lees says. "And some emerging markets, notably Brazil and Indonesia."

He also says its worth looking for opportunities to arise from the eventual turn in the US dollar, which in his words is "inevitable but not necessarily imminent".

Author: Chris Lees and Nudgem Richyal -  co-manages Pendal Global Select Fund

Funds operated by this manager:

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