Monthly Investment Review -07 February 22

Global vision



Long-term macro regime. Growth below potential and more volatile inflation. Demographic and debt undermine potential growth. Coupled with digitalization, it fuels secular disinflationary pressures which collide with - cyclical - inflationary tensions

LT macro regime. Inflation durable irritation deteriorates business cycle perspectives Higher and much more volatile inflation will challenge the duration and the amplitude of expansion phases. Especially in the US.

Lower liquidity will fuel tighter financial conditions. Deceleration of excess liquidity is spilling-over across most asset classes and upsetting risk appetite

Pandemic is not over yet, but the odds of herd immunity later into 2022 are rising. Omicron will strain Western growth short-term. It represents a more serious medium-term challenge for China due to its Zero Covid policy

Geopolitics. US in front of a trilemma. Ukraine, Indo-Pacific (Taiwan) and Middle East (Iran) may become three concomitant fronts

Serious unwinding of speculative capital flows. Massive outflows in January, namely from over-leveraged / disabused retail investors

Unstable equity-bonds correlation, but no regime shifts yet. Financial repression is waning, but negative real rates will remain in force in 2022. US long rates to stabilize around 2.0%

A succession of risk-off / on periods ahead. A cocktail of complex events is unfolding. Geopolitics, irritating inflation (and a maneuvering Fed), as well as likely delicate US politics in H2 (controversial mid-terms).


Global Macro fog will prevail at least up to next summer - The odds for a decent 2022 year in terms of growth are significant. We expect a ¨growthflation¨ regime to develop in 2022, featuring above potential growth in the US and Europe. Inflation will continue to irritate western countries and clearly stay above central banks’ target up to late in 2023. The capacity of central banks to confront upset financial markets and sensitive governments (US democrats) will be key on the one hand. In an adverse scenario, a serious fiscal drag could unfold in the US if the Biden administration fails to pass even a down-sized Build Back Better plan.

Rarely forecasting economic outlook has proved so delicate. First, the resilience of the pandemic will continue to trigger highly disparate political responses and disturb supply chains as well as labor markets. The timing and the magnitude of China’s eventual reflation is particularly tricky to determine. Risks are growing of an energy crisis linked to geopolitics, not only of natural gas in Europe, but also of oil in the context of Iran. In the past, all serious energy crisis ended-up with collapsing business cycle…

The serious resurgence of inflation, as well as the procrastination of the Fed and the ECB, provide good insurance that the cycle duration will be shorter (say around 4/5 years) than during the last decades (Great Moderation). The bond market, i.e. the relentless flattening of the US yield curve, is adamant about it. The latest forecasts of the IMF (published late-January) provide some insight in this respect. 2022 global growth is revised down half a point to 4.4%, slowing down to 3.8% in 2023. As a reminder, world growth near 3.0% is synonymous of a recessionary framework.

Asset allocation conclusion - But despite recent markets jitters, financial conditions will remain relatively supportive. It would take further USD strength coupled with higher interest rates to render us more cautious. For now, we maintain a fully invested allocation, but with a somewhat more cautious positioning within asset classes. Stay exposed to precious metals. As a hedging asset, US duration is becoming attractive with US 10-year yield nearing 2.0%.



Since 2015, the USD is going nowhere - Macro investors who tend to gravitate toward momentum trades have lost interest in the USD. The realised volatility over the period is at an all-time low. What appears somewhat at odds is the strength of the USD in the face of the easing of record financial conditions. The sign of correlation suddenly changed. Recently, the USD as a safe haven in times of uncertainty has been backed up by the tight correlation to Global Economic Uncertainty. The higher the uncertainty, the stronger the USD, and vice versa.

The 2021 dollar strengthening was most likely down to the relative overperformance of the US economy to the rest of the world and investors’ appetite for US growth stocks. Those factors are in the rear view mirror. The focus will return to the twin deficits doom loop. For those wondering why this did not translate into more sustained weakness in 2021, possible answers are that the US 2-year yield was much higher and that it works with a 2-year lag.

However, given the still current stretched positioning on the currency, there is not many investors left to buy the USD. Furthermore, it is trading at the top of end of its historical valuation. Even if valuation is a poor timing tool, that does not mean it is completely irrelevant. In terms of the G10, JPY, SEK, and NOK are cheapest with CHF and NZD the most expensive versus their respective 30-year REER averages.

A different story for EM is insight - Historically, at the start of the Fed tightening monetary policy, the first thought is that it is not time to load up on EM FX. Many of the high yielding currencies in the EM basket are cheap and they yield a lot in nominal and real terms. Last year was awful and they underperformed G10 by the most in 20 years. While it seems a silly idea to overweight in a year where risk premiums could head higher, a lot higher, it might prove surprisingly different thanks to the fact that China central bank is easing its monetary policy. China credit impulse lead EM currencies improvement by 6 months.



Inflation outlook not less of a concern - The headline inflation surged to a 40-year high in both US (7.0%) and Germany (5.3%) while inflation expectations have recently receded. In late 2021, inflation was mostly driven by rising commodity, higher input prices and core components. This uncomfortable truth is addressed by the Fed. In December, it has decided to scale back its bond purchasing program by a further $15bn a month to $30bn and purchases are set to cease by March. The Fed has rapidly stopped purchasing TIPS, and by consequence pushed up real yields and breakevens down . Long-term expectations are no longer pricing in an above long-term average inflation.

Powell added that an extended intermission between the phasing out of QE and the first rate hike was unnecessary. The Fed will hike in March.

Quantitative tightening is coming - The Fed conducted a balance sheet shrinking (QT) from 2017 to 2019 and introduced a cap on its monthly reduction (run-off rate). The Fed will fully or partly refrain from reinvesting the proceeds from maturing bonds, this will reduce excess liquidity. Last time, the Fed started out cautiously with a monthly cap of $10bn, which was gradually raised to $50bn. QT ultimately led to tight liquidity conditions, and then the Fed had to buy T-bills in 2019 to improve it. As the balance sheet is now much higher, tighter dollar liquidity ought to be somewhat less severe, even more if as the PBoC takes over. We are expecting the Fed to reduce its balance sheet by c. $100bn per month (US Treasury + MBS). It will be officially launched during summer.

The initial reaction to QT in 2017 was a decent upward movement in long US yields. Then, as we moved into 2018/2019, yields began to fall as renewed weakness was perceived in the US economy and the markets began to focus on the Fed hiking cycle coming to an end.

The upward pressure on long yields from QT stems in part from the term premium being pushed higher. The idea of QE is to compress the term premium (push long yields down) and to stimulate the economy. The exact opposite is now happening. The term premium will increase in 2022 when the Fed begins to reduce its balance sheet. That would tend to steepen the yield curve – or at least reduce the flattening pressure from rate hikes. Uncertainty on the inflation outlook should also push the term premium up.

The market has already started pricing this scenario. It is currently discounting more than 4 rate hikes of 25bps in 2022, but only a little over 2 rate hikes of 25bps in 2023. We find the 2022 pricing too aggressive; we also see a potential for further rate hikes to be priced into, especially in 2023.

The 10-year German yield has transitory turned positive for the first time since 2019 and US 10-year yield is moving towards 2.0%. We expect yields to continue rising through 2022. While an ECB rate hike in 2022 is not our baseline scenario, we expect markets to increasingly price rate hikes in 2023 and 2024. The US 10-year Treasury yield will hit 2.25% in 2022 and the Bund 0.3%.

EM Inflection point is coming – The light investors positioning in EM local markets is a development that would help EM assets to stabilize and perform this year. Local EM bonds’ foreign holdings are showing signs of nearing or having reached a bottom, following several years of outflows and de-risking away from EM. Foreigners’ exposure has decreased by a third since 2013 peak. Steepest reductions occurred in CEEMEA, while LATAM bond markets have been relatively spared. Asian exposure has remained immune but still lowest at only 14%.

Repricing of EM bond yields toward higher levels has quickly occurred, in response to much higher US yields. An increasing number of EM countries will pivot over the coming months toward a “living with COVID” strategy. This trend will likely help to largely ease market participants’ fears regarding a scenario of stagflation in EM, to be replaced by growthflation.

In addition to the positive technical factor on investor positioning, global developments over recent weeks suggest that several tailwinds may soon be materialized for EM assets. The inflection point for a more positive narrative on EM assets is on the horizon. A stable or weaker USD would be the trigger.



The return of sector and geographic diversification - From 2017 to 2021, the Nasdaq outrageously dominated the markets with a performance of nearly 200% compared to 88% for the S&P 500 Equal Weight, 85% for the MSCI World, 30% for the Euro Stoxx, 50% for the Nikkei and 42% for the MSCI Emerging. During the pandemic, valuation gap has widened sharply between technology stocks (and other speculative companies) and the rest of the market because of the huge liquidity injected to support the economy.

With the tightening of the Fed's monetary policy, we are witnessing a transition from a liquidity market to a fundamentals market, implying a derating – re-pricing - of growth stocks and the return of volatility. And above all, the return of the diversification in sectoral and geographical terms, favoring the Value and cyclical segments - Finance, Industry, Materials and Energy - as well as regions with a predominant Value and cyclical weight such as Europe and Japan with 60% in their indices. The financial sector (see graph below) reacts the most favorably when interest rates rise.

Without coming as a big surprise, the start of the year was difficult for the stock markets due to unfavorable seasonality, a transition resulting in a re-pricing of high PE ratios and fears of more monetary tightening by the Fed, faster than expected. Added to this, there is an extreme tension between Russia, NATO and Europe over Ukraine.

2022 should deliver a positive performance:

  • Profit growth is expected at +10% in the United States and Europe for 2022 and 2023. Margins will remain high; companies in both services and industry are confident in their pricing power, i.e. their ability to pass prices onto customers. In the United States, the net margin of the S&P 500 is estimated at 12.8% in 2022, compared to 12.6% in 2021, whereas the average between 2011 and 2020 had been 10%.
  • Analysts anticipate breaking 2021 records for global M&A and US share buybacks.
  • If history is any guide, the S&P 500 is advancing in the beginning of a monetary tightening by the Fed. According to Truist Advisory Services, since 1950, out of 12 cycles of Fed Funds increases, only the 1972-1974 period (oil crisis) saw the S&P 500 retreat.
  • However, we have revised our targets for the S&P 500 to 5,100 and the Stoxx 600 to 555 for 2022.

The pandemic and liquidity have pushed investors to buy growth stocks and large cap stocks, defensive segments in a destabilized global economy. Liquidity also favored speculative securities - meme stocks - bought by Robinhood investors, stuck at home and receiving checks. The more favorable outlook for the global economy with normalization of production and supply chains, as well as the end of the labor shortage, will make the segment of small and medium-sized companies more attractive.


The Oil, between geopolitics and economic recovery - The price of Brent is at its highest since 2014. The breakout of $87 opens the way to $100 a barrel. Demand is stronger than expected and OPEC+ is increasing production step by step, while inventories are falling in the main global hubs. Levels in Cushing, Oklahoma, are at their lowest in 10 years, while consumption in the United States is at its highest for this period in 30 years due to a freezing winter.

Russia-Ukraine-NATO tensions are pushing prices higher. Current prices include a geopolitical premium. Russia accounts for 10% of world oil production. In the event of a military conflict in Europe, there is little doubt that prices would soar; How far? Hard to say. Probably over $100-120. JPMorgan estimates it at $150.

Crossing the $100-120 mark would not be good news for the financial markets, because investors would be integrating a real risk of an economic slowdown. We doubt Russia will embark on a damaging military campaign and producers are aware that a too high barrel price would jeopardize global economic growth. Technically, Brent is in a highly overbought zone and in the short term we expect prices to decline. We would no longer buy oil company stocks, waiting for a correction and buying opportunities. In addition, high prices are accelerating the production of shale oil in the United States, even if it is hampered by the rising costs of transport and steel, as well as the difficulty of buying the equipment necessary for exploitation of new wells.

There are also unfavorable structural factors that explain high prices over the medium to long term, like for industrial metals, which result in poor visibility on the profitability of new projects. These factors are: geopolitics, climate, environmental constraints and energy transition. Oil companies fear incorporating current prices to make investment decisions, as by 2030 demand is expected to decline with the energy transition. The consultant Carbon Tracker has issued a warning to oil companies on the profitability of exploration projects based on current prices; they could waste $2.2 trillion in this decade with the rapid advance of carbon-free technologies. This analysis is valid for thermal coal.


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