Last Week in a Nutshell
- The last US job report confirmed the creation of 467K jobs in January, beating estimations and despite the surge in Omicron cases. Equity markets were mixed and volatile. Government yields spiked.
- Preliminary estimates showed that the euro zone economy grew by 0.3% last quarter, the slowest growth in three quarters, but in line with expectations, as Omicron spread across the region.
- Stating that higher inflation will fade through 2022, the European Central Bank left its rate unchanged. Market participants seemed to think otherwise and started pricing in the odds of hike(s).
- The Bank of England raised its interest rate for a second time in 3 months, to 0.5%. While it was an expected move by the bank, nobody expected such divergent opinions among its members.
What's Next?
- The US CPI reading for January is due and highly awaited. Inflation is peaking in numerous countries, challenging central banks to communicate and act.
- The Q4 2021 earning season continues, highlighting a bigger drag on Q1 2022, a guidance ratio similar to the pre-pandemic one and a bright spot with an expected increase in capex.
- The geopolitical conflict triggered by the move of Russian troops towards the Ukraine border continues, a little too close to home for European investors.
- The Winter Olympic Games 2022 continue in Beijing. A few countries sent athletes but no government officials in a diplomatic boycott over China's human rights abuses.
Investment Convictions
Core scenario
- The latest messages sent by the Fed (interest rate lift off and balance sheet run off) will condition performance in 2022. On a medium term, liquidity reduction is a turning point.
- After the rapidly rising interest rates and equity rotation out of Defensives and Growth segments and into Cyclicals/Value over the past month, we will likely enter a digestion phase.
- Elevated inflation and strong growth, while expected to fade in 2022, should drive interest rates and bond yields higher. A gradual rate rise should support risky assets.
Risks
- Several uncertainties related to the pandemic, the healing of COVID-19-related disruptions, central bank communication and geopolitical tension will likely lead to market volatility.
- A brutal, faster-than-anticipated rate tightening in the US - if inflationary pressures increase and/or persist - could jeopardize the recovery.
- The Omicron infections 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.
- Finally, geopolitical tension in Eastern Europe could push energy prices further and weigh on investor sentiment.
Recent actions in the asset allocation strategy
Strong economic performance should continue into 2022, with growth of around 4% both in the United States and in the euro zone and close to 5% in China. We expect supply and demand will gradually rebalance in an above-potential growth context in major developed economies. As strong demand faces pandemic-related supply bottlenecks, tensions arise and are leading to higher prices. Hence, inflation should remain uncomfortably elevated, at least during the winter months. We expect the beginning of a Fed rate hike cycle to be a very delicate time, during which we prefer keeping a short duration. For equity markets, above-potential growth leads us to begin 2022 with a constructive stance on equities, mainly via European and Emerging markets and Financials. We downgraded the energy sector after a strong performance and identifying higher potential upsides on other sectors.
Cross asset strategy
The shifts in economic and inflationary regimes will call for a dynamic equity allocation. We expect inflation to peak in Q1 2022 as bottlenecks start to ease. We will focus on value and risky assets until growth shows resilience and inflation decelerates. We are currently overweight equities.
- We have exposure to assets related to the post-COVID rebound/recovery
Overweight equities, underweight bonds. Within equities, preference for European and Emerging Markets through China-A onshore stocks, then Japanese and US equities.
Underweight government bonds, keeping a short duration. We focus on the source of the highest carry, i.e. emerging debt. We stay neutral European investment grade credit, we downgrade US investment grade. We have a currency exposure to the NOK. - Positive stance on financials, materials and energy – assuming that Q1 2022 sees inflation peaking and bottlenecks easing.
- In our core long-term thematics: Tech & innovation, healthcare and climate, as they reveal high growth potential over the medium term beyond short term volatility.
