As market participants are adjusting to a new monetary policy regime as well as to slowing growth from last year’s stellar levels, equities might remain volatile. Nevertheless, solid corporate earnings growth and gradually rising yields continuously support our preference for stocks and credit over low-yielding bonds.  

Emerging market equities underperformed global markets significantly in 2021, leaving them attractively valued. As growth conditions across emerging markets improve, especially in China, we expect emerging market stocks to outperform. Emerging economies, especially in Asia, are also easing monetary policy measures, which makes them appealing over developed markets. Therefore, we have opened an overweight position in the region over global equities – considering that Russia represents less than 3% and 1% of emerging and global equity markets, and less than 4% of emerging market revenues. This is why we think the global earnings picture is unlikely to be impacted materially. 

A different path 
In recent months there has been increasing divergence in monetary policy between central banks in the west and those in emerging economies. We expect central banks in several emerging economies to relax monetary policy to help boost slowing economic growth. Despite inflation being elevated, China has lowered interest rates to help cushion the downturn and we anticipate further cuts. Central banks in emerging economies that hiked aggressively in 2021, such as Brazil, will likely stop raising interest rates, and even cut them if growth slows. 

Covid-19 watch 
New infections have peaked in Europe and the US, with the number of new cases falling by more than half in the UK and by two-thirds in the US since January’s highs. European countries are beginning to relax Covid-19 measures, with Sweden, Denmark and Norway lifting nearly all of their pandemic-related social restrictions. The UK has said it will abolish all Covid-19 regulations, while the US has also relaxed mask requirements. China is still trying to contain outbreaks via its ‘zero tolerance’ policy.

The pace of economic growth has moved past the peak and is now beginning to slow. While the market is finding it hard to catch up with this new reality, including the consequences of the escalating Russia/Ukraine conflict, we see this as a normalisation from super-strong rates. We’re not concerned about this as we expect growth to remain above-trend in 2022, even if uncertainties have increased. While equity markets had a bad start to the year, they have recovered from the lows thanks to persistently solid earnings growth, before they came under renewed pressure due to latest geopolitical developments. 
However, we still see a good chance that the end of this cycle has not been reached yet. 

Central banks are now catching up with above-target inflation and are starting to withdraw their emergency stimulus. The Bank of England (BoE) has already raised interest rates and the Fed is expected to follow, with markets expecting several rate increases starting in March. While we continue to monitor the consequences of the latest developments around Russia closely, for now we also expect the European Central Bank (ECB) to hike interest rates before the end of the year, helping the euro to recover against the dollar. While the Russia/Ukraine crisis complicates the near-term market outlook, at this stage we expect any volatility to be relatively short term.

In response to the pandemic, the US government and the US Federal Reserve (the Fed) deployed vast amounts of monetary and fiscal stimulus to help keep the economy on track. In contrast, several emerging market countries have already seen their policy rates rise sharply as central banks responded to high inflation. Having front-run tighter US policy (with the rate lift-off likely in March), and with a possible rebound of economic activity now that Covid-19 vaccination is progressing, emerging markets may be about to turn a corner, also helped by a slightly weaker US dollar. Financial conditions may start to ease before long in emerging markets, while they will likely tighten further across the US and Europe.

Market volatility will probably remain high and safe-haven assets supported. Investors will also focus on energy and commodity prices more generally. From a macro perspective, Europe in particular is exposed to rising oil/gas prices (Brent is past USD 100 per barrel). This could become a stagflationary shock if protracted (rising inflation/slowing growth). 

From a market point of view, portfolio diversification at times of high uncertainty is helpful and important. 

Rather than timing the market around geopolitics or other events, we rely on fundamental analysis together with thorough risk considerations. There are downside risks to growth and upside risks to inflation, especially in Europe, which is more sensitive to potential disruptions to energy supplies and oil/gas price shocks. But this could turn central banks more dovish once again and, in any case, the global, US and Asian economies are unlikely to be impacted materially. 

The well-diversified long-term foundation of our portfolios helps weather geopolitical and other storms better. Rigorous diversification across regions and asset classes becomes especially relevant in times when local market risks dominate. A global approach to asset allocation delivers better risk-adjusted returns over time, reducing the portfolio’s volatility to less than the sum of its parts and protecting better against idiosyncratic risks.  

You can read more about our views on the Ukraine-Russia crisis in our latest CIO note.

I’d also like to take this opportunity to tell you about the Quintet Earth fund, the world’s first multi-asset, climate-neutral investment fund, which provides exposure to green bonds and low-carbon equities. You can find out more about this unique fund in this video.

Despite the economic cycle normalising from super-strong rates and Russia/Ukraine/
geopolitics taking centre-stage, we think economic growth will remain above trend in 2022

Playing Catch-up

COUNTERPOINT
MARCH 2022