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25.11.2021  

Global Investment Views - December 2021

Published November 25, 2021

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The “real” puzzle


Halloween ‘ghosts’ of Fed tapering, the Evergrande crisis, and the earnings season did not scare the markets. The Fed telegraphed its message well: while keeping the option to adjust tapering depending on the state of the economy, it reiterated the “transitory” inflation narrative. The BoE proved more dovish than expected, actually keeping rates unchanged (‘benign neglect’) regarding inflation risk. As a result, nominal yields declined and real yields fell to near new record lows. Although CBs are sticking to their temporary wording, our view, in contrast, is that the latest CPI readings support the “sticky” narrative.

On equities, the earnings season has overall been strong. Another area for concern, the possible default of Evergrande in China, was averted once again and we expect policy intervention to kick in to avert a default again, if necessary. In the US, even as President Biden reappointed Powell as Fed Chair to ensure continuity in monetary policy, he confirmed Brainard as the Vice Chair. But some volatility will likely return amid Democrats’ efforts to pass the Social Infrastructure Bill through the Senate (due to be passed before 13 Dec.). The path looks uncertain, as does the final total amount of the package.

Lastly, we have entered a new Covid wave. Moving into the winter season in Europe and the US, cases will rise. However, we don’t expect this to derail the growth outlook, thanks to vaccination campaigns. On the other hand, it is difficult to see any significant upside after the recent highs in equities: Santa Claus gifts have arrived already. Range-bound equity markets and volatile bonds, with reduced liquidity across the board, is the most likely scenario through year-end. Against this backdrop, we keep our neutral stance in equities and short duration view in core bonds, and a mildly positive view in credit and peripheral bonds. In terms of portfolio construction, targeting real returns will be the name of the game.

  • Overall asset allocation will continue to favour equity, as no other choices are available moving to a late cycle. The equity stance will likely shift from neutral to a tactical overweight once the economy reaccelerates in Q2/Q3 2022. But the need for hedges will remain high as the risk of policy mistakes is on the rise. We also recognise that equity exposure has risen to a peak in the cycle, favouring DM and in particular the US, where valuations are now extreme. With the recovery broadening towards EM, where allocation has fallen below strategic targets and return potential is higher, we expect investors to start to reallocate towards these markets in the search for attractive valuations. Overall in equities, areas of bubbles persist. We don’t know which companies lack pricing power (swimming naked) because discrimination on this basis is yet to happen in markets. So, investors should favour quality/value, dividend names and stocks that indicate sustainable pricing power (not easy to measure).
  • Credit with higher yields and short duration may be the best means to navigate high inflation, but selection will be key as default rates will start to bottom out as financial conditions get less supportive.
  • Real assets will be favoured, as they can help in terms of inflation protection. There are many opportunities in this regard. On private debt, the floating rates available in this market and the liquidity premium may help with seeking income opportunities that are more resilient to possible increases in core yields in a market in which financing demand is on the rise. Infrastructure investing is also seeing strong momentum amid opportunities linked to the energy transition and this is also generally an asset class that provides inflation protection. Private equity is key to financing the recovery and to seeking higher potential returns. Real estate could also offer selective opportunities in the recovery phase.
  • Some ESG risks are becoming real. The COP26 meeting highlighted the need for urgent action on emissions reduction. The China-US last minute deal could mark a further reacceleration of this trend, which could lead to a rising demand from investors and eventually translate into higher market prices in a positive feedback loop.

We believe investors face a meagre real returns outlook for the next three years. In our view, a 60 equity/ 40 aggregate bonds portfolio’s real annual return could be close to zero both in the US1 and Europe2 . The investment puzzle for the future is how to increase real return potential. This will require grasping opportunities where available across all asset classes, as the real value left in the market is not abundant, underscoring the need for investors to maintain a wide arsenal of instruments.

1. 60% S&P 500 and 40% US Aggregate Bond. Assumption of 3.2% inflation.
2. 60% MSCI EMU and 40% Euro Aggregate Bond. Assumption of 2.1% inflation.

Chinese growth to stabilise in 2022


2021 has seen unprecedented regulatory changes amid the Common Prosperity pursuit. But policy clarity and coordination ahead should aid China’s structural transition.

The Chinese economy continued to suffer from its self-imposed policy constraints at the beginning of Q4, registering a weak recovery. The top culprits behind this slowdown are as follows:

  • The zero-tolerance Covid-19 policy;
  • Energy emission controls for high-polluting and high-emission sectors; and
  • Tightening in the housing market since Q4 2020.

Nevertheless, the broad weakness in the economy has caught policymakers’ attention. In October, the National Development and Reform Commission (NDRC) stepped up significantly to boost coal production to address power shortage issues, while some local governments began to remove energy use controls and resumed normal production. More relaxation is likely at the turn of the year, easing the pressures on the industrial side.

As for pandemic control and prevention, there appears to be little intent to change the zero tolerance policy before the Beijing Winter Olympics (4-20 February). But given the high vaccination rate in China, we do expect some adjustments to domestic travel policies after February. Operational adjustments on housing policies are also under way. That said, policy fine-tuning so far has been helpful in relaxing near-term liquidity pressures for developers, but this has not been material enough to change our assessment for a housing slowdown in the medium term.

Looking ahead, we expect the overall economy to restart its engine slowly, once the above mentioned constraints are removed one by one. However, the housing sector deleveraging is most likely to continue and it would be too complacent to expect another round of broad credit stimulus when the People’s Bank of China’s (PBoC) target is to keep a stable debt/GDP ratio. Hence, we expect policy easing to remain targeted, and an exit from abrupt deleveraging and tightening to be sufficient to help stabilise growth. We maintain our view that economic growth will rebound sequentially in Q4 from its dip in Q3 and then stay slightly below trend in 2022.

However, due to strong negative base effects, China’s headline year-over-year growth should drop to just below 3% in Q4 and print in a range of 3-4% in H1 2022 before bouncing back to above 5%. The major downside risk to our forecast is a sharper housing slowdown without additional policy stimulus.

From an investor perspective, this calls for vigilance in the near term as the country navigates its way through regulatory changes and towards ‘Common Prosperity.’ Beijing's tolerance of slower growth has increased notably, but we expect increasing policy clarity and coordination to assist in this structural economic transition. In the long term, we believe, these measures should reduce systemic risks, allowing us to explore opportunities through a selective lens.

To conclude, Chinese assets, including the CNH, offer strong diversification benefits to global portfolios in the search for higher real income, supported by the country’s expanding role in regional Asian trade and the government’s desire to increase the international relevance of the currency.

RC - 2021.12 - GIV - Figure1

Look for upside potential while limiting the downside


While remaining neutral on risk assets and diversified overall, there are selective opportunities to benefit from the mild, near term upswing in equities through options.

The global growth outlook has weakened slightly amid the narrative of persisting stagflation risks, but markets seem to be ignoring this for the time being and are focusing on robust earnings and momentum. We acknowledge this strength but believe investor vigilance must be maintained in light of concerns over future margin pressures. As a result, the scope for active management is high in bonds as well as in equities because what appears cheap and attractive on the surface may not offer sustainable returns in long run. We recommend that investors remain risk-neutral, looking for attractive entry points and exploring options to participate in any tactical upside. In addition, amid tight valuations, hedges to protect equity and credit exposure should be considered.

High conviction ideas

While we maintain our overall neutral stance on DM and EM equities, we are monitoring the current stronger-than-expected earnings season, particularly in the US, which has highlighted that the impact of supply bottlenecks on corporate margins has been muted. In the US, we slightly revised upwards the level at which we think equities may be tactically attractive. However, we remain active on this front, looking for any sign of weakening pricing power for companies. Based on an overall neutral approach, investors should look at a wide array of instruments, including derivatives, to play potential further moderate upside in US equities, but they should stay well balanced and diversified. On EM, we keep a neutral stance and are watchful for any near-term weakness in China. In bonds, we remain agile and identify opportunities from a tactical as well as long-term perspective across yield curves globally. Thus, we are tactically neutral on 10Y USTs now, as yields approached our target levels. However, this doesn’t represent any structural change to our cautious view on duration. In fact, we continue to see upside potential for yields in other shorter maturity segments on the Treasury curve. Secondly, UK 2Y yields also hit our target after the BoE’s decision not to hike rates.

On Italian peripheral debt – ie, the 30Y BTP vs the Bund – we remain constructive, given that Italian Q2 and Q3 GDP growth surprised to the upside, resulting in an improvement in the ratings outlook. In Asia, we continue to be positive on Chinese government bonds on account of our expectations of stable rates in the near term, diversification benefits, and weakening economic growth in the country. But on EM bonds, we stay neutral.

Credit offers returns potential, especially EUR IG and HY, as spreads remained resilient to core yields, fundamentals and technicals are improving, and CBs maintained their support by keeping short-term rates anchored. In Europe, high-beta segments, such as HY and subordinated debt, are attractive areas to exploit amid the downward trend in default rates.

At a time when valuations in many corners of the markets are full, FX offers relative value opportunities. In general, the Fed’s modest policy normalisation should be marginally supportive for the USD as we approach year-end. We like the FX carry basket favouring the GBP vs the CHF. However, against the USD and the EUR, we stay cautious on the GBP due to geopolitical issues and the effect of inflation on consumer purchasing power. In EM, we are constructive on the RUB/EUR due to the former’s attractive valuation and the Russian CB’s hawkish stance. In Asia, our positive view on the CNH/EUR remains in place as the country will continue to be the driver of regional trade and the government’s objective of making China a global superpower should also be supportive of the CNH. However, we now believe that weakening capital flows to Korea could affect the won in the near term.

Risks and hedging

Despite continuing growth, the inflationary regime presents a high risk to the markets in terms of its potential impact. We think investors should use cost-efficient hedges to protect HY credit exposure while maintaining protection for their DM equity holdings.

RC - 2021.12 - GIV - Figure2

Direction of real rates in focus


CBs embrace a benign neglect approach to inflation and stay behind the curve. Investors should stay active and monitor the direction of real rates which will affect asset valuations.

Economic growth remains strong, but projections point to a weakening environment (growth dispersion). On the other hand, inflation remains elevated, driven by a supply-demand mismatch, commodity prices, and pressures emanating from the labour market. Overshooting inflation is testing CBs’ patience to act: the Fed announced tapering plans, as expected, but the BoE kept rates unchanged (CB asynchrony). We think markets are trying to judge the tolerance threshold of CBs to inflation even though the Fed clarified that ‘transitory’ inflation pressures from supply bottlenecks could last until H2 2022. As real yields continue to be at unsustainably low levels, we remain cautious on govies and instead search for income in peripheral countries, DM credit and EM bonds through a very selective, active approach.

Global and European fixed income

On duration, we are defensive but flexible in the US and core (slightly less so now) and semi-core Europe. We also remain cautious in the UK and Canada. However, on Italian peripheral debt (strong growth), China (diversification), and Australia, our constructive stances remain in place. In credit, a positive outlook on ratings and Q3 results indicate no widespread warnings from supply bottlenecks. But volatility in core yields, dispersion in evolution of financial ratios, and yearend liquidity issues are potential fragilities.

We explore short-dated debt (low duration risk) with high spreads through higher emphasis on credit selection. We also see an acceleration in deleveraging in HY and BBB- compared to A-rated debt and continue to explore the rising star theme. While doing all this, we carefully monitor ESG dynamics and incorporate this factor into our overall selection process.

US fixed income

The markets seem to have bought into the Fed’s temporary inflation narrative, despite the recent data and the rising political echo of the inflation theme. We also believe fiscal stimulus will recede, but not as much as market expects. Thus, we stay positive on breakevens (compared to Treasuries), but recommend some fine-tuning due to valuation concerns. On USTs, we are defensive, owing to higher government spending and debt, and continuing economic growth, but are tactically managing our stance. In credit, we remain moderately constructive in IG and HY through a more selective lens. Another source for yield is the consumer, residential mortgage and securitised markets amid robust consumer savings, but we are very vigilant. We also seek selective opportunities in securitized credit (RMBS, ABS).

EM bonds

EM bonds are an area of interest, especially in a world of low yields and given our expectations of prudent policy normalisation by the Fed. We are positive on HC and keep our bias towards HY over IG, but are cautious on LC. Interestingly, upside inflation surprises continue to drive EM CBs to front load their tightening, notably across EEMEA and LatAm. We focus on commodity-driven countries (Russia) and sectors while we have turned vigilant on Brazil and Turkey.

FX

CBs’ delays in hiking rates could affect FX and we are actively following these developments. We maintain our long view on the USD and given the BoE’s recent decision, we are keeping a neutral view on the GBP. On EM FX, we are positive on the RUB, IDR and COP given their high carry and commodity exports.

RC - 2021.12 - GIV - Figure3

GFI = global fixed income, GEMs/EM FX = global emerging markets foreign exchange, HY = high yield, IG = investment grade, EUR = euro, UST = US Treasuries, RMBS = residential mortgage-backed securities, ABS = asset-backed securities, HC = hard currency, LC = local currency, CRE = commercial real estate, CEE = Central and Eastern Europe, JBGs = Japanese government bonds, EZ = Eurozone, BoP = balance of payments. 

A positive earnings season, with some clouds


Equities still offer attractive riskadjusted returns, but the situation is more nuanced as inflation is a major issue for companies, underscoring the importance of selection.

Overall assessment

Markets have been buoyant in recent weeks, led by strong earnings, encouraging forward guidance and progress over economic reopening as multiples expanded. However, three factors stand out for us: inflationary pressures, relative and absolute valuations, and real rates. The last factor – ie, when rates start to rise – will challenge higher equity multiples and that could aggravate the distinction between companies that possess pricing power and those that do not. This, coupled with high valuation dispersion in the markets, underscores the importance of our disciplined bottom-up process through which we identify companies that have the ability to pass on rising costs to consumers. Thus, it is an opportune time for selectively playing rotations favouring quality and value stocks.

European equities

In an overall tilt towards economic reopening, we are exploring names in the value, quality and cyclical spaces, led by our selection efforts. We find such names in financials and industrials even though we are slightly less constructive. Robust earnings in this season from financials and cyclicals further convince us of our stance. At the other end of the barbell, we like names in defensive sectors (healthcare). However, pricing power is key in a world of rising costs and to judge this we evaluate a company’s brand portfolio, intellectual property, etc. In contrast, we remain skeptical of hyper-growth tech names and discretionary sectors. ESG remains in focus amid momentum driven by policy measures such as EU green deal. Overall, we look at the E and S aspects as pools of opportunities that allow us to participate in the green transition and which could reduce inequalities without compromising returns.

US equities

Sentiment remains strong at a time when markets touched new highs, driven by positive results for S&P500 companies, which have for the time being successfully navigated supply chain disruptions and elevated inflation. Now, as we await clarity on the labour market and wages, we are watchful of whether companies are willing to give up some margin to protect a bit of market share. This remains a key input in our decision-making: ie, whether pricing power can be sustained. We are constructive on high-quality cyclical value names over defensive stocks, but believe stock selection will drive returns, as each company differs in its capacity to address operational issues on the supply and labour sides. However, we are cautious about bond proxy (long duration) sectors, high momentum/growth (technology, including large-cap tech), and distressed value names. At a sector level, we continue to prefer financials and energy over industrials, particularly where we can tilt the company-decision making towards promoting green energy and reducing carbon emissions. Consumer sectors appear fully valued and are exposed to labour and supply chain issues.

EM equities

Prospects of EM-DM growth premiums widening in 2022 and cheap relative valuations should support EM equities, but we suggest defensive positioning until year-end due to low visibility on market direction. The near-term Chinese outlook is affected by uncertainty over the current slowdown, although the long-term story is intact. Elsewhere, we are optimistic on Russia (commodities, energy exporter), Hungary and India. At a sector level, we prefer energy over materials, discretionary and communication services, and we keep a preference for value/cyclicals over growth.

RC - 2021.12 - GIV - Figure4

Amundi asset class views


RC - 2021.12 - GIV - Tab

Definitions & Abbreviations


  • Agency mortgage-backed security: Agency MBS are created by one of three agencies: Government National Mortgage Association, Federal National Mortgage and Federal Home Loan Mortgage Corp. Securities issued by any of these three agencies are referred to as agency MBS.
  • Beta: Beta is a risk measure related to market volatility, with 1 being equal to market volatility and less than 1 being less volatile than the market.
  • Breakeven inflation: The difference between the nominal yield on a fixed-rate investment and the real yield on an inflation-linked investment of similar maturity and credit quality.
  • Carry: Carry is the return of holding a bond to maturity by earning yield versus holding cash.
  • Core + is synonymous with ‘growth and income’ in the stock market and is associated with a low-to-moderate risk profile. Core + property owners typically have the ability to increase cash flows through light property improvements, management efficiencies or by increasing the quality of the tenants. Similar to core properties, these properties tend to be of high quality and well occupied. Core strategy is synonymous with ‘income’ in the stock market. Core property investors are conservative investors looking to generate stable income with very low risk. Core properties require very little hand-holding by their owners and are typically acquired and held as an alternative to bonds.
  • Correlation: The degree of association between two or more variables; in finance, it is the degree to which assets or asset class prices have moved in relation to each other. Correlation is expressed by a correlation coefficient that ranges from -1 (always move in opposite direction) through 0 (absolutely independent) to 1 (always move in the same direction).
  • Credit spread: The differential between the yield on a credit bond and the Treasury yield. The option-adjusted spread is a measure of the spread adjusted to take into consideration the possible embedded options.
  • Currency abbreviations: USD – US dollar, BRL – Brazilian real, JPY – Japanese yen, GBP – British pound sterling, EUR – Euro, CAD – Canadian dollar, SEK – Swedish krona, NOK – Norwegian krone, CHF – Swiss Franc, NZD – New Zealand dollar, AUD – Australian dollar, CNY – Chinese Renminbi, CLP – Chilean Peso, MXP – Mexican Peso, IDR – Indonesian Rupiah, RUB – Russian Ruble, ZAR – South African Rand, TRY – Turkish lira, KRW – South Korean Won.
  • Cyclical vs. defensive sectors: Cyclical companies are companies whose profit and stock prices are highly correlated with economic fluctuations. Defensive stocks, on the contrary, are less correlated to economic cycles. MSCI GICS cyclical sectors are: consumer discretionary, financial, real estate, industrials, information technology and materials. Defensive sectors are: consumer staples, energy, healthcare, telecommunications services and utilities.
  • Duration: A measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates, expressed as a number of years.
  • High growth stocks: A high growth stock is anticipated to grow at a rate significantly above the average growth for the market.
  • Liquidity: The capacity to buy or sell assets quickly enough to prevent or minimise a loss.
  • P/E ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).
  • QE: Quantitative easing (QE) is a type of monetary policy used by central banks to stimulate the economy by buying financial assets from commercial banks and other financial institutions.
  • Quality investing: This means to capture the performance of quality growth stocks by identifying stocks with: 1) A high return on equity (ROE); 2) Stable year-over-year earnings growth; and 3) Low financial leverage.
  • Rising star: A company that has a low credit rating, but only because it is new to the bond market and is therefore still establishing a track record. It does not yet have the track record and/or the size to earn an investment grade rating from a credit rating agency.
  • Semi-core Europe: Countries with higher government bond yields when compared to Germany (but lower than Peripheral yields) and includes nations such as Belgium and France.
  • TIPS: A Treasury Inflation-Protected Security is a Treasury bond that is indexed to an inflationary gauge to protect investors from a decline in the purchasing power of their money.
  • Value style: This refers to purchasing stocks at relatively low prices, as indicated by low price-to-earnings, price-to-book and price-to-sales ratios, and high dividend yields. Sectors with a dominance of value style: energy, financials, telecom, utilities, real estate.
  • Volatility: A statistical measure of the dispersion of returns for a given security or market index. Usually, the higher the volatility, the riskier the security/market.
  • Yield curve steepening: This is the opposite of yield curve flattening. If the yield curve steepens, this means that the spread between long- and short-term interest rates widens. In other words, the yields on long-term bonds are rising faster than the yields on short-term bonds, or short-term bond yields are falling as long-term bond yields rise.

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