Last Week in a Nutshell
- With 7.5% YoY, the US CPI reading for January showed a solid rise in prices, driving financial markets to speculate on a 50 bps interest rate hike by the US Federal Reserve Bank in March.
- Although the ECB opened the door to rate hike(s) this year, President Christine Lagarde highlighted that the process should be gradual as to not block recovery.
- The British economy grew by 7.5% in 2021. Recovering from a lower base, it now beats its neighbouring countries while the US, Canada and Japan’s growth rate have yet to be published.
- China’s Caixin Service and composite PMI figures came in at a disappointing 51.4. The plunge in domestic and overseas demand, high price of raw material; impacted optimism on the service sector.
What's Next?
- The reading of the UK CPI will shed some light on the odds of a 25bps vs 50bps interest rate hike by the Bank of England at their March meeting.
- Q4 2021 earnings season will wind down. While the ongoing season provide evidence for upward revisions in aggregate, it may not be enough to offset the higher rates.
- Tensions between Russia and the West over Ukraine should persist. Newly elected German Chancellor Olaf Scholz will visit Ukraine and Russia while NATO defence ministers will meet in Brussels.
- The G20 finance ministers and central bank governors will meet. An obvious discussion topic is inflation. A less obvious one is the challenge on the IMF’s global leadership role.
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. For now, the rise in real yields is sharp and the rotation in equity factors is bringing more volatility.
Risks
- Several uncertainties related to the pandemic, the healing of COVID-19-related disruptions, central bank communication and geopolitical tension will likely all contribute 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. Central banks’ credibility in their forward guidance and the evolution of the growth-inflation context has shortened our investment horizon. The lack of clarity in markets’ direction lead us to trim exposure towards neutral.
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 sector exposure.
- via China and
- via Latin America
- In our fixed income allocation: We keep a short duration and diversification, via emerging debt and inflation-linked bonds
- In our long-term thematics and trends allocation:
Our convictions spread across the privileged Health Care, Demographic Evolution & Consumption thematics and we will look for additional attractive entry points in Climate Change and Innovation.
