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June 2022 / MARKET OUTLOOK

2022 Midyear Market Outlook

Transitioning to a New Paradigm

Key Insights

  • Russia-Ukraine conflicts, COVID‑19 lockdowns in China, higher energy prices, and rising interest rates could make the second half difficult.
  • A spike in bond yields punished equity valuations in the first half. The question now is whether an earnings slowdown will be the next shoe to drop.
  • U.S. Treasuries and other core bonds didn’t offer much diversification in the first half as equity correlations jumped. New approaches may be needed.
  • Conflicts in Ukraine and sanctions against Russia could continue pushing commodity prices higher but also could accelerate a shift to renewable energy.

Adjusting to an Uncertain Future 

Heading into the second half of 2022, higher inflation and rising interest rates remain the most serious threats to global financial markets, T. Rowe Price senior investment leaders say.

Russia-Ukraine conflicts have added fire to those risks by pushing food and energy prices sharply higher and further disrupting global supply chains.

This inflationary “shock on shock” has put more pressure on the U.S. Federal Reserve and other major central banks to tighten monetary policy, while making it more difficult for them to tame inflation without choking off economic growth, according to Sébastien Page, Head of Global Multi‑Asset and Chief Investment Officer (CIO).

“The three biggest challenges for investors over the next few months will be inflation, inflation, and inflation,” Page says. “It’s the transmission mechanism for all the other risks we are facing.”

The key question now is whether those risks will cause a sharp deceleration in growth or push major economies into full‑blown recessions, dragging corporate earnings down as well, Page warns.

Beyond the cyclical risks, investors need to consider that global markets may have reached a structural inflection point—an end to the era of ample liquidity, low inflation, and low interest rates that followed the 2008–2009 global financial crisis (Figure 1).

The Era of Tame Inflation and Ample Liquidity Appears To Be Over

(Fig. 1) U.S. inflation* and the yield on the U.S. two-year Treasury note

May 31, 2006, through May 31, 2022.

*Inflation = year-over-year change in U.S. Consumer Price Index for All Urban Consumers. 
YoY = Year‑over‑year.
Sources: U.S. Bureau of Labor Statistics and the Federal Reserve Bank of St. Louis.

“I think that regime is over,” says Arif Husain, Head of International Fixed Income and CIO. “You can throw away that playbook.”

Central bank liquidity was critical for stabilizing economies and markets during both the financial crisis and the coronavirus pandemic, notes Justin Thomson, Head of International Equity and CIO. But it helped push valuations for many risk assets toward historical extremes. “I think we’ve learned from history that those extremes are never permanent,” he says.

In volatile markets, active management can be your friend.

- Justin Thomson, Head of International Equity and Chief Investment Officer

However, the new paradigm also could offer potential opportunities for investors with the skills and research capabilities needed to seek them out, Thomson adds. “In volatile markets, active management can be your friend.”

Explore our four themes:

Themes DescriptionLink
Navigating Challenging CurrentsRussia-Ukraine conflicts, COVID‑19 lockdowns in China, higher energy prices, and rising interest rates could make the second half difficult.Click to view
Fundamentals MatterA spike in bond yields punished equity valuations in the first half. The question now is whether an earnings slowdown will be the next shoe to drop.Click to view
Flexible Fixed IncomeU.S. Treasuries and other core bonds didn’t offer much diversification in the first half as equity correlations jumped. New approaches may be needed.Click to view
Managing Through Geopolitical RisksConflicts in Ukraine and sanctions against Russia could continue pushing commodity prices higher but also could accelerate a shift to renewable energy.Click to view

Summary

The shocks inflicted on markets in the first half of 2022 required global investors to adjust their expectations for inflation, interest rates, earnings growth, and volatility. But a longer‑term adjustment also may be necessary, the T. Rowe Price CIOs say.

“We are in the midst of a paradigm shift here,” Thomson says. “We’re moving from a low‑yield, low‑inflation, low‑volatility environment to one of higher inflation, higher rates, and probably higher volatility.”

New conditions may force many investors to unlearn some old ideas, like the notion that the Fed and/or the other major central banks can be counted on to pump liquidity into the markets if asset prices fall too far or too fast—a concept popularly known as the “Fed put.”

Now, “the Fed put is either gone or deeply out of the money,” Page says. If anything, he argues, investors face the potential for a “Fed call.” If risky assets rally too exuberantly in the second half, an inflation‑wary Fed might respond by hiking interest rates more aggressively, choking off any rebound.

Lessons From the Past

Previous paradigm shifts offer some unsettling examples of markets caught off guard either by valuation excesses or external shocks—or both, Thomson says.These past episodes include:

  • The 2000–2002 dot‑com crash, which illustrated the enduring importance of basic valuation fundamentals like cash flow and earnings.
  • The highly concentrated U.S. large‑cap market of the early 1970s, which was slammed by oil supply shocks and rampaging inflation.

But history doesn’t have to repeat, Thomson observes. “The way central banks are dealing with inflation is more sophisticated this time. I think that will lead to better outcomes than we saw for the duration of the 1970s.”

But the new paradigm also will require investors to pay close attention to their time horizons and tolerance for risk.

“Risk tolerance doesn’t usually get tested in normal times,” Page cautions. “You only truly understand your risk tolerance during regime shifts.”

You only truly understand your risk tolerance during regime shifts.

- Sébastien Page, CFA Head of Global Multi‑Asset and Chief Investment Officer

Above all, we believe investors should understand the risks of remaining passive in a fast‑changing market environment. Capitalization‑weighted indexes may be poorly positioned for structural change, making skilled active management a critical tool for identifying risks and opportunities.

“In the middle of a paradigm shift, doing nothing can be a very dangerous thing,” Husain says.

2022 Midyear Tactical Views

2022-midyear-market-outlook

*For pairwise decisions in style and market capitalization, boxes represent
positioning in the first asset class relative to the second asset class.

The asset classes across the equity and fixed income markets shown are represented in our multi‑asset portfolios. Certain style and market capitalization asset classes are represented as pairwise decisions as part of our tactical asset allocation framework. 

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. The views contained herein are as of June 2022 and are subject to change. Information and opinions, including forward looking statements, are derived from proprietary and non‑proprietary sources deemed to be reliable but are not guaranteed as to accuracy.

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The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. 

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