Global equity markets continued to rise in December. They were up nearly 4% in EUR to end 2021 with an impressive performance of 31% for the year in developed markets and 27% including emerging markets.
Developed markets were the top performers last month: Europe led the way (+5,5%) followed by North America (+3%). Emerging markets remained flat and ended the year well behind western markets.
Bond yields moved higher, with US 10-year yields rising from 1,45% to 1,51% and German 10-year yields moving from -0,35% to -0,18%.
On the commodities side, oil made a comeback after a tough November. Oil prices returned to their November levels, rising from USD 65 to USD 80 per barrel in a market environment where the more cyclical sectors delivered impressive performances relative to growth sectors.
Central banks around the world held meetings in December and made moves to tighten their monetary policy. While the US Federal Reserve (Fed) said it intends to raise rates and taper its asset purchases, the Bank of England has already taken the plunge and increased its key rates. The European Central Bank (ECB) is preparing to end its exceptional pandemic support programme but is not planning to raise its rates.
In anticipation of these monetary tightenings, almost all emerging country central banks also raised their key rates.
December’s economic indicators confirmed the economic picture that has been painted for several months.
Economic activity is strong, demand is robust, unemployment is falling, wages are climbing, and confidence indicators are positive overall.
That said, inflation is still top of mind for many people. This is reflected in December’s inflation figures. These hit record levels and were confirmed by the messages out of the central banks, which warned that inflation could persist in 2022.
The second major event in December was the spread of the COVID‑19 Omicron variant, which sowed doubt for a time on the markets. Just a few days after it was discovered, the health authorities confirmed that, despite its high spread, Omicron was a more benign variant than Delta.
In short, the most rapid phase of economic growth is now behind us. Growth rates were at an all-time high in 2021 after the recession in 2020. Growth should remain above the long-term trend in 2022, but is naturally expected to be weaker than in 2021.
Against this backdrop, most market analysts agree that we can expect a positive but modest performance on the equity side (<10%), while bonds could take a hit in a rising rate environment.
We therefore maintain our preference for equities over bonds and remain positive on developed markets versus emerging markets. From a sector standpoint, we maintain a balance between cyclical sectors that benefit from higher rates and high demand, on the one hand, and long-term trends, on the other. On the fixed-income side, we continue to believe that it is better to maintain a shorter duration than the market, given the inflationary environment and monetary tightening. At the same time, we think it makes sense to keep some cash in a diversified portfolio, to be able to take advantage of attractive entry points in the hunt for yield on the bond market. The monetary tightening we will see in 2022 could lead to some volatility, which has the potential to be profitable.
December saw renewed volatility on the markets, a symptom of the uncertainty weighing on investor sentiment. Investors appear to be caught between fears of tighter health restrictions, which would once again dampen the economic recovery and the rebound in the most cyclical stocks, and the possibility of a sharp rise in interest rates – to curb runaway inflation – which, in the medium term, would favour value and have an adverse impact on growth company valuations.
This year, the traditional Christmas rally favoured Value while new statistical studies on the lethality of the Omicron variant drove western governments towards a form of relativism. More specifically, the MSCI World Value ended the month up 5,5% while the MSCI World Growth struggled to add 1,0%. In this type of market, it made sense that the MSCI Europe would lead the way, at +5,5%, while the MSCI World and MSCI North America gained 3,2% and 3,0%, respectively. Lastly, emerging markets are still paying the price for highly restrictive health policies, like the "zero-COVID" policy launched by Beijing. Implementation of this extremely strict policy, against the backdrop of US-China geopolitical tensions, stifled momentum in the Chinese markets, which ended the month down 4,1%.
With no real visibility, we continue to believe that only long-term qualitative investments will be relatively profitable. However, more value-oriented investment themes can be played in the medium term as persistent inflationary pressure is expected to trigger rate hikes. This rise in rates could weigh on the valuations of growth companies (even high-quality ones), temporarily favour financials, and support companies that have some pricing power. These two visions, while slightly divergent, can nevertheless be nicely balanced within a portfolio and offer some relative diversification, as well as attractive optionality.
Sectorwise, we therefore still like tech, industrial and healthcare companies. They are continuing to make effective investments in R&D – as demonstrated by the number of vaccines and antibody cocktails developed in record time – and still boast attractive valuations. Despite some high valuations, liable to take a hit from inflationary pressure in the short term and from rate hikes, tech stocks still harbour extraordinary growth opportunities due to strong demand, particularly for cloud services. In the short term, the more cyclical stocks in the sector could continue to benefit from the economic recovery and the pressure it is putting on demand for semiconductors. Similarly, industrial companies, which are more fairly valued, are set to continue performing well and see their business stimulated by the economic recovery and the implementation of major infrastructure plans on both sides of the Atlantic. In the longer term, they should also benefit from positive momentum linked to the digitisation and automation of industrial processes. Most industrial companies also appear to have emerged from the current crisis with optimised cost structures and sound balance sheets, which could pave the way for external growth transactions.
This month we also increased our exposure to consumer discretionary, with a preference for market segments likely to be able to take full advantage of the economic recovery by tapping households’ excess savings and deploying some pricing power. The luxury goods sector comes to mind, in particular.
Conversely, we decided to limit our exposure to the real estate sector, which is expected to be hurt by the shift to new post-pandemic societal paradigms and by an excessively sharp rise in rates. We also maintain our negative view on the Basic Materials sector, due to its excessively limited long-term visibility; the Utilities sector, which is expected to suffer from interest rate hikes; and the Consumer Staples sector, which has few levers to protect its margins from more persistent-than-expected inflation.
Sovereign yields trended higher in both Europe and the United States, in a market environment dominated by the central banks’ tone.
Yields fell sharply at the beginning of the month, driven by defensive market movements against the backdrop of the development of the Omicron variant. While new restrictions were imposed that could put the short-term cycle at risk, consensus preferred to bet on a minor impact on economies. Speculation that Omicron is less dangerous, combined with economies’ ability to cope with previous waves, also helped maintain the status quo.
Eyes were therefore mainly on the Fed, which the market expected to take a more aggressive turn after it said that inflation could be less transitory than expected. That was the environment in which the Fed announced that it would accelerate its asset purchases, signalling an end to its tapering in the first quarter and not the second, as previously anticipated.
Meanwhile, ECB Vice-President Luis de Guindos agreed with Schnabel that the factors driving inflation in Europe are taking a more structural turn and simultaneously affecting economic growth. Rates rose quickly as a result, but only temporarily, dropping right back down again after the announcement of the new Omicron variant.
For its part, the Fed initially announced that it would start tapering its asset purchase as expected, causing the curve to flatten further. Towards the end of November, the Fed cut its purchases of US sovereign bonds and MBS by $10 billion and $5 billion, respectively. December will see monthly securities purchases shed another $15 billion, a pace set to continue in the coming months. This scenario implies that net purchases would end in June 2022, in line with consensus expectations. However, in his testimony to the US Senate Banking Committee, Powell announced that inflation would not be as transitory as initially expected and that the Fed is ready to speed up the tapering process. This statement caused the US yield curve to flatten and market participants to expect net purchases to end in around three months.
All in all, inflation is likely to last longer than expected, keeping pressure on rates. We recommend maintaining an underweight position in Europe, while keeping slightly shorter duration versus the market in order to preserve the diversification effect of asset classes from a cross-asset perspective. We still have a slightly negative view on US yields and recommend taking a slightly shorter positioning than the market to obtain duration that would keep the benefits of the asset class for risk management purposes.
The credit market
December proved fairly positive for credit: it ended the month in the black in Europe and broke even in the United States, outperforming sovereign debt.
This performance stemmed mainly from risk premium compression. If investors were concerned about the explosive spread of the Omicron variant, the ECB’s announcements offered some reassurance. The European institution stated that it would continue to reinvest funds from maturing bonds in its asset purchase programmes until at least 2024. Additionally, as expected, the end of the pandemic emergency purchase programme (PEPP) will be accompanied by an increase in purchases under its traditional programme (APP), which will be expanded from EUR 20 billion to EUR 40 billion per month.
The euro/dollar exchange rate remained stable at about 1,14 in the last month of the year. This marked the end of the strengthening of the dollar, which had continued unabated between May and November. Overall, economic data in both regions ended in positive territory in December, and this optimism is reflected in the rise in sovereign yields on both sides of the Atlantic. The future of the exchange rate will crucially depend on the monetary policy trajectories the central banks take in 2022. For now, the markets expect monetary tightening to be more aggressive in the United States than in Europe. Inflation and the economic fallout from the Omicron variant wave will be the biggest key challenges for monetary policy in 2022.
Gold had a fairly decent December and climbed back above the USD 1.800 per ounce mark, rising more than 3% from USD 1.774 to USD 1.830. This rally does not, however, offset its poor annual performance. As the stars seemed to have aligned for gold to gain ground (high inflation and negative real rates), its negative performance (price per ounce -3,5% in dollars) disappointed investors in 2021. Gold did not meet its expectations as a hedge against inflation, unlike equities which benefited greatly from this high-growth, high-inflation environment. The new year is shaping up to be a challenging one for gold since real rates are expected to climb on the back of the central banks’ upcoming tightening.
The information and opinions contained in this document have been taken from reliable sources. Spuerkeess cannot, however, guarantee their accuracy, comprehensiveness or relevance. The information and opinions contained in this document have been provided to Spuerkeess’s clients purely for information purposes and should not be construed as an offer of purchase or sale, investment recommendations or advice, or any commitment from Spuerkeess. Clients must form their own opinion about the information contained in this document and, to help them to do so, they are free to contact their usual advisers if they have any investment-related questions. The information and opinions should under no circumstances be used as a basis for evaluating any financial instruments referred to in this document. Any reference to past performances should not be construed as an indication of future performances. The contents of this document reflect Spuerkeess’s opinions on the date of publication. Any information or opinions contained in this document may be removed or amended at any time through a new publication. Spuerkeess does not any accept any liability for this document if it has been altered, distorted or falsified, particularly through online use. Nor can Spuerkeess be held liable for any consequences that may result from the use of any of the opinions or information contained in this document. As a Luxembourg credit institution, Spuerkeess is subject to the prudential supervision of the Commission de Surveillance du Secteur Financier (the Luxembourg financial supervisory authority). This document was produced by the Private Banking Unit and Spuerkeess Asset Management. The writing of this document was completed on 24 January 2021 at 3:27 pm. This document may not be reproduced or shared with third parties without the prior written consent of Spuerkeess. Unless otherwise indicated in this document, there are no plans to update it.