Last Week in a Nutshell
- In a volatile week, market sentiment declined further as monetary policy, geopolitical and credit uncertainties continued to dominate.
- In the US, both the New York Empire State and the Philly Fed manufacturing surveys came out below expectations. But January retail sales were reported at 3.8% MoM, smashing expectations of a 2.0% rise.
- In China, the National Development and Reform Commission mentioned that it will guide platforms to cut fees. This represents new regulatory headwinds for China’s food delivery platforms.
- In Europe, as several countries are edging closer to loosen their coronavirus restrictions, confidence in the economic recovery is improving as seen in the ZEW investor survey.
What's Next?
- After military drills under the eyes of Russian President Putin, investors are looking forward to diplomatic talks between US Secretary Antony Blinken and Russian Foreign Minister Sergei Lavrov.
- On the data front, February flash PMIs and the German ifo business climate will kick off the week. Consumer confidence from several countries will help assess the inflationary backdrop on households.
- Speaking about inflation, France and Belgium will be among the first to report preliminary data for February. Given on-going tensions on energy markets, expectations are for an uncomfortably high level.
- Regarding central banks, several Fed and BoE speakers will express their opinions on the size of the upcoming rate hikes. Investors will weigh how steep the tightening cycle is to be this year.
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 Growth segments and into 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. For now, the rise in real yields is sharp and the rotation in equity factors is bringing more volatility.
Risks
- 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
Central banks’ credibility in their forward guidance and the evolution of the growth/inflation context has shortened the investment horizon. The lack of clarity in markets’ direction lead us to trim equity exposure towards neutral. Strong economic performance should however continue in 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. As expected, the beginning of a Fed rate hike cycle is a very delicate time and we have no choice but to deal with uncertainty.
Cross asset strategy
The shifts in economic and inflationary regimes will call for a dynamic equity allocation. We still expect inflation to peak in Q1 2022 as bottlenecks start to ease.
- Our most recent strategy adjustments to the shorter investment horizon include a more neutral positioning on equities:
- via a decrease in the exposure on euro zone equities and on US small and mid-caps.
- via a newly-built allocation to 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.
