Coffee Break 12/20/2021

Please note that your "Weekly Coffee Break" will not be released on 27 December 2021, due to the Christmas holidays.
Next release will be on 3 January 2022.
Merry Christmas and best wishes for a happy and successful New Year!
The Weekly Coffee Break Editorial team

LAST WEEK IN A NUTSHELL

  • The Federal Reserve took a hawkish turn during its last Federal Open Market Committee of the year. The median FOMC member is now ready to start a new interest rate hiking cycle in 2022.
  • The ECB retained its stance. With the euro zone further away from full employment, the ECB will remain accommodative. The hiking of its short-term rate before mid-2023 would come as a surprise.
  • December flash PMI’s showed a cooling but still solid pace of manufacturing and services activity as supply chain bottlenecks seem to be easing but Omicron restrictions limit mobility.
  • The EU leaders’ summit highlighted the current situation regarding COVID-19 and various issues related to the EU's external relations (energy prices, security & defence and migration).

 

WHAT’S NEXT?

  • Investors will focus on the accelerating spread of the Omicron variant as countries move to more stringent restrictions, as well as what this could mean for the recovery and economic policy in 2022.
  • Among the few events on the calendar to look out for, the European Commission will release its advance December consumer confidence
  • Both the Conference Board’s consumer confidence measure and the final Michigan consumer sentiment index for December will be released in the US.

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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