Why investors should look beyond economic headwinds

Investors pause for a rethink, but there are reasons to remain optimistic

September 02, 2022
  • David Rea

Right now, there’s no getting away from an economic outlook that makes decision-making a challenge.

The three main, interconnected headwinds of political uncertainty, the cost of living, and the cost of money have combined to stall investors. For real estate, caution holds sway; the bid/ask gap is widening as all markets reconcile pricing.

Uncertainty lingers, particularly in relation to conflict in Ukraine, but also around China’s zero COVID-19 policy and continued disruption to international supply chains. With each passing month, GDP growth forecasts for most countries are being incrementally revised down, with the International Monetary Fund having cut its global growth projections for 2022 and 2023.

In Europe, the risk of Russia restricting gas exports has raised the very damaging prospect of energy rationing this coming winter, as well as much higher prices. High energy industrial users are likely to be the most acutely affected.

The cost of living, or for business the cost of operating, is negatively impacted by rising fuel, electricity and commodity prices. A slow central bank response has meant that price pressures have spread broadly across economies, driving up inflation. Higher inflation has given businesses cover to raise their prices, but these are not increasing as fast as general inflation nor the increase in input costs.

Meanwhile, the cost of debt, or cost of funding, has taken economies into new territory after more than a decade of cheap money. While late to begin, major central banks have been moving aggressively and financial markets have priced in the full tightening cycle to come into bond yields and swaps. Debt and capital are now more expensive, something you can read more about in my last commentary on the ECB’s recent rate hike. The higher returns on offer for government bonds are a disincentive to invest in more risky assets, especially given the increasingly uncertain outlook.

Lower impact

It’s a lot to contend with. However, there’s plenty of reason to look beyond this period of reflection and hiatus.

Real estate investors may be on a price discovery journey right now, but there’s a depth and diversity of both lenders and investors, which won’t go away – and should lessen the risk of a lengthy impact on capital flows and investment activity.

Further, while many economies are facing a slowdown, there are few underlying vulnerabilities that would typically propagate a recession or amplify a downturn. The banking system is stable and well capitalised, and corporate balance sheets are in reasonable shape.

Employment is high, unemployment in Europe this year reached a record low, and wages are rising quickly, even if not as quickly as inflation. Re-entry to European offices is at its highest point since the onset of the pandemic, as my colleague, Alex Colpaert, recently covered. Household balance sheets are healthy and stronger than before the pandemic, even if much of the exceptional savings accrued during lockdown has been spent.

Finally, while inflation is currently high, long term inflation expectations remain modest and have fallen, because of the softening outlook. This is likely to limit the so-called feedback loop of inflation fuelling itself and mean a return to normal rates of inflation in the medium term. It’s why looking beyond the short term should give comfort.