The matrix of uncertainty provides a framework for assessing today’s economic environment and aids in making investment decisions, says Epoch Investment Partner’s John Tobin.
Key Takeaways
- For investors, navigating the matrix of uncertainty can help identify investment opportunities in the current environment
- Each of the six elements is connected to the next uncertainty, and steers the outcome of the following
Stubbornly high inflation, rising interest rates, slowing economic growth, new strains of covid and the Russia/Ukraine conflict have resulted in sustained and ongoing market volatility in recent times.
John Tobin, portfolio manager, Epoch Global Equity Shareholder Yield strategies, says these six key issues have created a matrix of uncertainty, with many market experts questioning the economic outlook scenario, and the direction each of these elements will take.
But for investors, navigating the matrix of uncertainty can help identify investment opportunities in the current environment, says Tobin.
In the matrix of uncertainty, each of the six elements is connected to the next uncertainty, and steers the outcome of the following.
The first uncertainty faced by investors is inflation, and there are two scenarios that can play out, Tobin says.
The first is that we could see inflation levels start to ease. But in this scenario, there is a counter argument that even if inflation eases, it has already crept into the price of services. As services represent more than 70 per cent of the developed economy, this will have a marked impact.
But the second scenario is that inflation could persist, in which it would have a knock-on effect for interest rates (another uncertainty in the matrix), Tobin adds.
Should we expect central banks to continue to move aggressively, raising rates by significant amounts at each meeting? Or could we see central banks take their feet off the brakes?
– John Tobin, portfolio manager, Epoch Global Equity Shareholder Yield strategies
In the scenario where inflation begins to ease, it could result in central banks beginning to ease off on interest rate policy, Tobin says.
“The result could be a decision to raise rates by only 25 basis points every time, down from the 50-75 basis points they are acting on now. Of course, even in this ‘benign’ scenario, rates are still headed higher as central banks attempt to normalise policy.
“The decision of central banks on the interest rate front has implications for economic growth – the next uncertainty in the matrix. Do we have a recession? Is it mild or severe? Or do we avert a recession altogether and have a soft landing?”
Compounding all of this – and the next uncertainty in the matrix – is the oil price.
“This year we have seen oil prices increase dramatically followed by a roll over. Over time we have seen that the price of oil is a mean-reverting time series. As the old saying goes, the cure for high oil prices is high oil prices. Are we now seeing this familiar pattern play out again, and should we expect oil to continue to fall toward what has been the long-term mean in the mid-$60s?
“But as the world’s economies begin to grow, so does the demand for oil. It is possible that the state of supply is tighter than we think, and there is less excess capacity. In this case we could be stuck for some time in a high-priced oil environment—which, of course, circles back to inflation and how the two affect one another.”
Covid – and how governments are responding to new strains and outbreaks – is another uncertainty in the matrix, Tobin says.
“In the case of China, it continues to remain dogmatically attached to its zero covid policy, which has significant implications for supply chains around the world,” he says. “If another strain flares up in China, it may result in a further disruption of the major production centres there.”
Lastly, in the matrix of uncertainty, there are geopolitical considerations, like the Russia/Ukraine conflict.
“Will it continue into the foreseeable future, or are we close to the end? If there is a resolution on the horizon, and how will that resolution affect the global economic environment (such as gas prices in Europe, and global agricultural product supply and prices)?”
But there is also the uncertainty between China and Taiwan, and in Italy, where the government has collapsed with the resignation of prime minister Mario Draghi. The US is also preparing for its midterm elections, and the UK just appointed a new prime minister.
If one thing is clear, it is that there is a tremendous amount of uncertainty in the world today, and this makes investing more challenging and volatile. But the matrix of uncertainty provides a framework for assessing today’s economic environment and aids in making investment decisions, says Tobin.
“The matrix today highlights that we face an economic environment with a significant risk of recession, with higher interest rates and higher inflation. In such an environment, investors should be thinking more about being defensive in their investment strategies given the current state of the market rather than jumping back to ‘risk-on’ with both feet.”
This article is intended to provide general information only and does not take into account your individual objectives, financial situation or needs. Past performance is not necessarily indicative of future performance. You should seek independent financial and tax advice before making any decision based on this information.