Coffee Break 1/3/2022

LAST WEEK IN A NUTSHELL

  • China’s manufacturing activity continued to expand, by a slim margin. The official manufacturing purchasing managers’ index (PMI) rose to 50.3 in December, up from 50.1 in November.
  • In the US, regional pricing data already published so far for December – New York, Philadelphia, Dallas and Kansas City – showed less inflationary data points but CPI will remain hot for the next two prints.
  • The Omicron variant cast gloom over festivities for a second year as larger cities had to call off New Year celebrations. In the US, the rising wave caused disruptions, including airline cancellations.
  • China called for tighter restrictions to control an outbreak in Xi’an, pointing to the challenges of holding the COVID-19 zero line against the spread of Omicron.
  • 2021 ends with oil, a risk-on asset class, posting its biggest annual gain in 12 years spurred by the global economic recovery from the COVID-19 slump.

 

WHAT’S NEXT?

  • The first week of the year kicks off with a bang as there is plenty of economic data scheduled for release, including the US job report which should confirm rapid progress towards full employment.
  • Preliminary data on inflation in the euro zone will be released, with energy cost as a major contributor. A peak is expected early this year in the area while in the US, it is expected to happen a few months later.
  • December PMI figures will shed some light on the recent evolution of manufacturing and services activity, amid tentatively easing supply constraints and the Omicron wave.
  • This current wave is different as the Omicron variant is notable for its rapid transmission, as well as its reduced virulence.
  • Bilateral US-Russia talks will take place in Geneva on January 9-10, followed by a Russia-NATO Council meeting in Brussels two days later and negotiations in Vienna within the OSCE framework.

INVESTMENT CONVICTIONS

  • Core scenario
    • We continue to see upside and downside risks for risky assets into year-end, but we are more 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). With cautious central banks, “TINA” will continue to prevail in the months to come and support equities.
    • We have to navigate between bullish and bearish risks on equities as volatility has increased and year-end liquidity will be scarce.
    • 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 Delta and more recently Omicron variants, 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 prepare for 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 recently increased our exposure to equities.

  1. 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.
  2. Positive stance on financials, materials and energy – assuming that Q1 2022 sees inflation peaking and bottlenecks easing.
  3. In our core long-term thematics: tech&innovation, healthcare and climate, as they reveal high growth potential.

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