Since early November last year, following the election of Biden and the announcement of vaccine, the markets have remained bullish with the vast majority of risky assets rewarded by the market. We noted that, since this summer, the signs of nervousness were multiplying even if the markets remained well oriented. The trend has increased recently with rapidly rising rates, fears about growth and inflation, and strong sectorial rotations in equity markets.
The market has become mucho more defensive and cautious, as sector rotations were significant, sectors linked to the rise in long-term rates in particular were penalized. Investors have decided to take their profits, after the records of the last few months. Finally, the recent surge in energy prices has revived the inflation debate.
For the remaining of the year, we retain once again a positive view about market developments as fundamentals are still robust and central banks continue to be very supportive. We only use a portion of our risk Budget in our allocation, as market prices make it difficult to envisage a rapid rebound. In contrast, a major correction is unlikely and we see no reason to further reduce investors’ risk budget.
We see three main themes for the markets. Firstly, 2022. Next year is likely to be much more complicated with less favourable growth, potentially persistent inflation and less and les accommodating central banks. We forecast a global growth of 4.6% in 2022, compared to 5.9% expected in 2021; we expect a 4.1% growth in Eurozone compared with 5% in 2021. Secondly, inflation. Inflation surprises remain very high globally, but the debate has now shifted to the labour market and the potential of an emerging wage/price loop. Tensions on the labour market coupled with significant wage pressures, should continue to fuel the debate. Last but not least: growth. Growth remains strong, but the peak has indisputably been passed. The signs of bottlenecks are increasing signs of overheating activity. The news could be disappointing in the future. The economic surprises are negative, which is less favourable for the markets.
In short, the visibility over next year is much lower and the risks accumulate. Rather than stagflation we face an excess of demand that creates bottlenecks and make us believe that we could face at the same time an economic overheating since production cannot keep up with this frantic pace, and inflationary pressures that seem to be building up. A typical pattern at the end of a cycle where the role of central banks is to withdraw monetary support. All this gives a much more complicated market environment.
In conclusion, we remain constructive on the potential of markets next year, but the risk return arbitrage will certainly be much less favourable.