[Opinion] Invest According to Economic Trends Rather Than Inflation

If Economic Recovery Exceeds L-Shaped Stagnation
Prioritize Buying Bonds and Blue-Chip Stocks
Maintain Cash Ratio When Facing Economic Downturn Risks

If the main topic of the global real economy and financial markets in the first half of this year was inflation, the second half is expected to see a full-scale debate on the economy. With the U.S. economy already entering a technical recession after two consecutive quarters of contraction, the question is whether it will recover in a U-shaped manner (the current possibility of a V-shaped recovery is very slim), stagnate in an L-shaped pattern, or continue negative growth leading to a recession characterized by an overall decline in economic activity.

A U-shaped recovery is currently the best-case scenario and requires inflation easing as an essential prerequisite. In the second half of the year, demand recovery may occur reflecting year-end consumption in the U.S. and next year’s Chinese Lunar New Year consumption. Inflation is expected to stabilize after peaking in the second and third quarters, allowing central banks worldwide, including the Federal Reserve, to have room to adjust the pace of tightening policies. Under this scenario, a hopeful outlook for the real economy next year is possible. Although this scenario is not impossible, it is difficult to realize because it requires inflation stabilization and positive outlooks and actions from global economic agents.

An L-shaped stagnation is currently seen as the baseline scenario. As the global real economy enters a mid-term slowdown cycle, it is hard to deny that the macroeconomic and financial market environment, including inflation and monetary tightening, is negative for the economy. Therefore, from the second half of this year through next year, global real economic growth is expected to decline significantly, with intermittent negative growth occurring. However, since this is sufficiently anticipated and prepared for, it is a scenario where no sudden shocks to the real economy or financial markets will occur. Given that this is the situation that governments, central banks, and major private economic agents will strive to achieve, it is expected to have the highest likelihood of realization.

The possibility of entering a full-fledged recession with continued negative growth cannot be ruled out. If inflation is not controlled and high energy prices and cost increases persist, pressure on economic contraction may intensify in private consumption, private investment, and net exports. Focusing on the U.S. economy, forecasts are gradually emerging for six consecutive quarters of negative economic growth from the third quarter of this year through the fourth quarter of next year. If this materializes, it would mean a recession lasting two full years. The problem is that if high inflation persists during the recession, there is a risk of a full-scale stagflation, a phenomenon where economic stagnation and rising prices occur simultaneously.

In the first half of the year, global stock and bond markets both weakened. The bond market reflected inflation, intense monetary tightening, and the stock market reflected adjustments and contractions in the real economy, along with earnings declines and valuation discounts caused by rising interest rates. Going forward, it will be important to see how downward pressure on the real economy unfolds. It is necessary to consider the upside potential and downside risks based on the L-shaped stagnation as the baseline scenario. If upside potential beyond L-shaped stagnation is expected, buying bonds and blue-chip stocks is advisable; if downside risk below L-shaped stagnation is anticipated, maintaining cash holdings is recommended.