Last Week in a Nutshell
- US consumer price inflation continued to rise, jumping to 7% YoY in December. Disruptions to the global supply chain caused by the pandemic appear to have peaked this winter.
- Fed Chair Powell and Vice Chair designate Brainard confirmed that the Fed would raise rates and reduce its balance sheet. This news sparked volatility on the markets.
- The last monthly GDP reading in the UK surprised on the upside as the economy grew by 0.9% in November, returning to pre-pandemic level.
- ECB president Christine Lagarde confirmed that everything will be done to get inflation to 2% over the mid-term.
What's Next?
- The Q4 2021 earnings season starts in earnest with big US banks. 39 S&P 500 companies will be reporting. Earnings guidance will be key.
- China will release its Q4 GDP reading, the last reading on its economic activity before the country shuts down for 2 weeks to celebrate the Lunar New Year on February 1st.
- The Bank of Japan will meet and should keep its monetary settings as is and revise up its inflation forecast for the fiscal year beginning in April.
- Other G20 central bank decisions will come from Turkey and Indonesia this week, and there will also be announcements in Norway and Hungary.
Investment Convictions
Core scenario
- We continue to see upside and downside risks for risky assets, sparking volatility, but we are overall constructive for 2022.
- Our central scenario is that the economic recovery will continue, far from being at the end of the cycle (GDP +3.9% in the US and +4.3% in the euro zone in 2022, +4.9% in China). “TINA” will likely continue to prevail in the months to come and support equities.
- Beyond concerns about the Omicron variant, we believe that the medium-term context remains positive for equities, value stocks and assets and short duration on fixed income.
Risks
- First and foremost, the coronavirus infections, due to the Omicron variant, and lower temperatures in the northern hemisphere underline the risk of a stop-and-go in economic restrictions.
- Second, supply side constraints are numerous and will last longer than expected. A situation of extreme supply tension could also eventually impact not only economic growth but also corporate earnings’ growth.
- Third, a brutal, faster-than-anticipated rate tightening in US financial conditions - if inflationary pressures increase and/or persist - could jeopardize the recovery
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, the context of a potential yield curve steepening combined with above-potential growth leads us to begin 2022 with a constructive stance on equities, mainly via the euro zone and Emerging markets.
Cross asset strategy
The shifts in economic and inflationary regimes will call for a dynamic equity allocation. As we enter Q1 2022, inflation should peak and 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 recently sold some USD vs EUR, as the dollar failed to strengthen despite the 2Y yield surge.
- 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.
