Last Week in a Nutshell
- Most of the international community rallied to call out Russia as they launched an assault on Ukraine. Financial markets’ volatility spiked while economic growth in the euro zone could be challenged.
- Sanctions in the days ahead of the invasion were criticized for not going far enough, fast enough, but could soon escalate further.
- Preliminary PMI came out strong as the re-opening of economies continues. Growth picked up especially in the service sector, boosted by consumer-facing activity, travel and tourism.
- The initial readings on French inflation showed a higher-than-expected surge in February
What's Next?
- Russia’s military actions in Ukraine put Russian President Putin’s potential strategy to move further into the country and how NATO allies could respond in the future in the spotlight.
- US president Joe Biden will deliver his State of the Union speech to the US Congress and address the current condition of the nation. Russia, inflation and the coronavirus pandemic are on the agenda.
- Jerome Powell will testify before Congress, laying out the Fed’s view on how steep the path towards monetary tightening should be.
- On the data front, the US monthly job report should confirm that the labour market recovery is gaining traction. Participation rate and wage developments will be particularly scrutinized.
Investment Convictions
Core scenario
- The Russian military invasion of Ukraine might lead to significant tensions and alter the market outlook over the medium term. Diplomacy will prevail over war and, therefore, a scenario of above-potential economic growth would remain the most likely.
- The latest messages sent by the Fed (interest rate lift off and balance sheet run off) and the steepness of the path towards monetary tightening will condition performance in 2022. On a medium term, liquidity reduction is a turning point.
- In the US, elevated inflation and rather strong growth, while expected to fade in 2022, should drive interest rates and bond yields higher.
- In Europe, we might continue to live with negative real interest rates for some time.
Risks
- The Russia-Ukraine conflict will push energy prices further and continue weighing on investor sentiment while sanctions usually end up hurting both sanctioned and sanctioning parties.
- A brutal, faster-than-anticipated rate tightening in the US - if inflationary pressures increase and/or persist - could jeopardize the recovery.
- The COVID-19 and its variants underline the risk of a stop-and-go in economic restrictions.
- Also, supply side constraints are numerous and will last longer than expected and extreme supply tension could impact economic and corporate earnings growth.
Recent actions in the asset allocation strategy
Central banks’ path towards rate normalisation is being challenged by the Russia-Ukraine conflict as high energy prices usually go hand in hand with lower economic growth or stagflation. The Fed will likely not change its stance in the short term but the ECB may mark a pause. Overall, central banks’ credibility in their forward guidance and the evolution of the growth/inflation context will remain key. The lack of clarity in markets’ direction had already led us to trim equity exposure towards neutral. Depending on how far energy prices and inflation go, strong economic performance should however continue in 2022. Inflation should remain uncomfortably elevated. We have no choice but to deal with uncertainty, especially in a context of challenging geopolitics
Cross asset strategy
The shifts in economic and inflationary regimes with the Russia-Ukraine conflict as backdrop will call for a dynamic equity allocation.
- Our most recent strategy adjustments to the shorter investment horizon and increased volatility include a more neutral positioning on equities, with more protection on our equities exposure:
- via a selling of our exposure to Euro zone banks
- via an increasing allocation to the US energy sector
- via a more balanced exposure to European vs US equities while keeping a preference for the UK big caps, resilient in volatile markets, with a Value factor exposure.
- via China (rebound of credit impulse) and
- via Latin America (support from rising commodity prices)
- In our fixed income allocation: We keep a short duration (as the rise in bond yields is not over in our view) and diversification, via emerging debt and inflation-linked bonds
- In our long-term thematics and trends allocation:
Our convictions spread across Health Care, Demographic Evolution and Consumption, Climate Change and Innovation. In the current context, we privilege the former, but setbacks on the latter thematics could provide attractive entry points. - In our currency allocation strategy: We added USD, JPY and CHF vs EUR
