Calmer Waters in the Months Ahead?

The first half of 2022 had been a nerve-racking experience for investors in financial assets, with inflation-proof instruments, particularly commodities, offering one of the few escape routes from the pain inflicted by endless Covid mutations, geopolitical shocks, and backward-looking fiscal and monetary policies.

Looking forward, there is reason to believe that, despite the decidedly challenging economic and political outlook, the financial markets are set for less stormy weather. This is because, with the exception of some unthinkable and devastating action with worldwide repercussions by Vladimir Putin in Ukraine and/or Xi Jinping in Taiwan, investors seem to have discounted most of the serious risks that lie ahead.

This is reflected in the latest BofA Investor Global Fund Manager Survey which shows levels of despondency no seen at any point since it was launched in 2001, with this rather surprisingly including the Great Recession of 2007-2009 and the emergence of the Covid threat in early 2020. The July risk-asset rally, whether sustainable or otherwise, may partly be attributed to this extremely gloomy investor sentiment.

Given this psychologically depressing backdrop, the second half of the year is likely to witness lower financial volatility. This expectation is not the product of mere guesswork. Interest rate volatility, one of the the best proxies for risk aversion, seems to be declining. Again, deep discounting by anxiety-stricken investors who have managed to come to terms with the calamities, real or apparent, seen on the economic and political horizon is apparently at work. The inflation picture is not getting any better, yet any new release of an unpalatable measure of one type or another of price pressures is reassuringly greeted with progressively less fear by players in the bond market.

This does not mean that the economic and political outlook is about to turn more rosy. Be that as it may, deep discounting of the worst possibly outcomes on virtually every possible financially sensitive front, and the decline in market volatility that it engenders, should allow investors to move forward in a more productive fashion in the months ahead. This is particularly true of those pursuing value-oriented strategies.

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