Global Asset Allocation: The View From Europe

1. Market Perspective

• Global economic growth expected to moderate through the year, but remains above trend. Elevated inflation remains a headwind, but expected to recede over the course of the year amidst central bank tightening and supply chain improvement.
• Developed market central banks advancing tighter policies, with the US Federal Reserve continuing to reduce its balance sheet and expected to raise rates in March, the Bank of England raising rates for the second consecutive time in February, European Central Bank curbing asset purchases, while the Bank of Japan remains on hold. Emerging market central banks may be nearing peak tightening, while China policy moving in opposite direction, with a series of easier policy moves.
• Short-term rates biased higher with central banks tightening, while long-term rates balance impacts of slowing growth and stickiness of inflation.
• Key risks to global markets include central bank missteps, persistent inflation, increasing geopolitical concerns, emergence of coronavirus variants and China growth trajectory.

2. Portfolio Positioning

As of 31 January 2022

• We remain underweight equities as valuations—although off recent highs—remain extended. Elevated inflation and rising wages are likely to weigh on corporate margins and earnings growth.
• Within equities, we continue to tilt towards cyclicality, maintaining overweights to value-oriented equities globally, US small-caps and emerging market stocks, where valuations are more reasonable and which should benefit from a continued path of recovery.
• Broadly across our fixed income allocation, we continue to favour shorter-duration and higher-yielding sectors through overweights to inflation protected securities, emerging market debt and high yield bonds supported by our still-constructive outlook on fundamentals.

3. Market Themes

Gimme Five, Powell!

Equity markets are off to their worst start of the year since 2009 as they continue to price in the Federal Reserve’s hawkish pivot and the probability of over five rate hikes this year. The drawdown in equities has been led by high-growth-oriented companies, notably in the technology and discretionary sectors, many of which rose to high valuations last year having benefitted from changes in consumer behaviour related to the coronavirus pandemic. Undaunted by the recent market weakness, Chairman Jerome Powell, at the Fed’s meeting last month, reiterated their intentions to aggressively remove policy accommodation, citing strong labour markets and high inflation. With 10‑year US Treasury yields already jumping over 40 basis points this year and mortgage rates following suit with a near 50-basis-point jump, the impacts are flowing through to the real economy. While the Fed seems set on its aggressive path forward, the flattening yield curve seems more worried about its potential impacts on growth and is questioning if we’ll get the high-five from Powell this year.

Pulling Out All the Stops

After a rocky 2021, investors were hopeful for a rebound in China amidst signs of easier policy support and slowing regulatory reform; however, the year has started with continued signs of slowing growth, much of which has been attributed to strict zero-tolerance policies around COVID-19. Investor confidence is waning as equity markets have slumped nearly 8% to start the year and creditors are still waiting to find a bottom in prices for much of China’s real estate-related debt sector. In response, China’s policymakers have taken early steps to ease policy, including cutting lending rates, lowering reserve requirements and flipping course on the property sector by freeing up home loans to stabilise prices, and more support is likely on the way. With China hosting the Winter Olympics and President Xi Jinping looking to extend his leadership to an unprecedented third term, policymakers are especially eager to pull out all the stops to avoid an economic crisis this year.

For a region-by-region overview, see the full report (PDF).