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Chief Investment Officer's team, 03.01.2022
Let us start by wishing you a very healthy, happy and prosperous new year for you and your beloved. Be sure that all our Wealth Management teams keep on working hard to contribute to the prosperous side of things, in a new working week. This publication will from now one be released every Monday afternoon.
2021 was another positive investment year. Cyclical assets surged: stocks from developed markets returned almost +22%, second only to listed real estate at +27%. By contrast, the fixed income asset class was negative across segments, especially for the most defensive ones, as interest rates and inflation materially picked up. This impacted the price of gold, down -3.6%. Finally, stocks from emerging markets were disappointing with a -2.5% negative return, almost exclusively due to China. Against this backdrop, our cautious, moderate and aggressive profiles delivered respectively +2.4%, +4.2% and +7.6%, beating our strategic asset allocation, Compared to competitors however, we gave back part of our spectacular 2020 outperformance, due to our capital preservation goals which implies holding more weight in defensive assets than our peers.
In full transparency, we start 2022 with less conviction than a year ago. “Investing in the Age of Magic Money” was a clearly procyclical theme, but the road ahead is more foggy. The backdrop is reasonably constructive as the recovery still has legs, and as we hope that the virus might actually be weakening. However, elevated valuations create vulnerability, and there is no shortage of concerns to trigger anxiety and volatility episodes, in a year of economic and political transition. We are getting ready to be, this time, probably more reactive than proactive. We will formally issue our 2022 Outlook later this month. Stay safe.
As a new year and a new decade begin, it is worth trying to get a sneak-view into the not-so-proximate future, and draw some conclusions as to whether portfolios should change, or to an extent not be run in the same way as before. Secular bears markets, that is markets where returns net of inflation are muted or non-existent on a multi-year time frame, are relevant to decadeinvesting, being they more frequent than one may think. While the most striking example of a secular bear market is the one which occurred in Japan after the bursting of the real estate bubble in 1989, the latest one is well known to the most of us, and ended in 2010 in the United States, following the bursting of the tech bubble in 2000. Yes, whoever invested at the peak of the IT bubble did not see his money back in real terms until 10 years later. The problem is that history teaches that secular bear markets were born out of spectacular bull runs, so it is now the time to re-consider the odds of a lost decade ahead of us, also considering by how much exorbitant Fed stimulus must have pulled forward future returns. We can only say that the odds are remarkably higher, hence future equity returns should be muted, in the low-to-mid-single digits including reinvested dividends. At the same time, it is tough to see US equity returns close to zero or outright negative, given the starting point of negative real rates. Bloated profit margins, expensive valuations - both typically mean-reverting - possibly a higher inflation regime and bottoming treasury yields make for a more challenging environment. Should we even allow for the birth of a new era, actually marked by higher economic growth rates, driven by higher investments in a greener economy supported by technological advance, fiscal stimulus and depressed real rates, that would come at the cost of higher macroeconomic volatility, hence portfolio volatility driving more return uncertainty, translating into higher odds of lower returns.
Assuming a more uncertain equity decade lies ahead, what should we do differently? What one should not do is to invest in a typical 60% equity, 40% bond portfolio, given low yields, the currently limited diversification benefits of treasuries and a potentially higher inflation environment driven by reflationary policies. What one should do is to look for yield in ‘hybrid’ asset classes sitting somewhere between bonds and equities, considering the higher uncertainty around expected returns. High-yielding bonds, preferred securities, REITs and convertibles tend to generate considerable income and to exhibit mean-reverting features. A certain degree of mean-reversion makes hybrids less risky than pure equities in the longer run, as for hybrids periods of below-average returns tend to be followed by periods of above-average returns more frequently than for stocks. Offsetting poorer returns via income-generation can be a winning strategy in the next decade. Hedge funds should also be on the radar screen. Swapping market risk for idiosyncratic risk, i.e. manager risk, can add value when market direction is more uncertain. In summary, if within the investable liquid universe traditional asset classes have less to offer in riskadjusted terms, investors should look into the appropriate alternative asset classes.
Fixed Income Update
A turbulent year for fixed-income investors is finally over. We saw a bear market in the long-dated treasuries for the first time in four decades. There was unprecedented volatility and lack of liquidity towards the end of the year in the rates markets. While developed market investment-grade credit did not provide anything exciting to talk about, developed market high yield credit ended the year on a high as the best performing hard currency segment. According to the unhedged Bloomberg Barclays index, China's local currency investment grade bonds returned an eyepopping 8.4%. Emerging Market Debt had a bad year due to the high duration exposure and increasing yields. So the real question is how we are positioned at the start of 2022.
We believe the 10-year US Treasury yields should increase by c. 30 bps from current levels in terms of our rates outlook. This is precisely half of the amount of increase in 2021. This means the effect on long-duration assets should be moderate. However, in segments where spreads are in the bottom quartile, such as investment grade, we do not see positive returns in 2022. Hence we will maintain our Underweight in both Developed Market bonds and investment-grade credit. High yield valuations are quite rich and are flirting with the bottom 25% mark. Hence, we believe the top performer of 2021 might have a more sedated return profile in 2022. Therefore, we continue our Neutral stance on the asset class. On the other hand, Emerging Market Debt spreads look attractive relatively. The most significant caveat on EM Debt is the performance of China. With the policy easing expected to gather pace, China credit performance should be better than that of 2021.
December was an interesting month for Asia High Yield as we saw the final confirmation of default by Evergrande. However, the Shimao funding situation has rattled the markets, especially as the investors that hold Shimao have less risk appetite than investors who had Evergrande or Kaisa bonds. Nevertheless, barring another negative surprise from any investment-grade credits from the region, the worst in the asset class could be behind us.
Closer home, MENA markets priced $90Bn+ bonds in 2021, with two-thirds of bonds issued in the first half. We would see an uptick in the issuance in Q1 2022 again as issuers would like to tap the markets before the Fed begins its rate hikes. However, the overall volumes, especially from the sovereign issuers, could be lower than 2021 as the oil prices remain stable and the financing requirements remain moderate. In terms of return expectations, we believe carry would be the major contributor towards the performance as spreads are firmly rooted in the bottom quartile range. Turkey short-end and Egypt belly may offer opportunities for aggressive investors.
YOLO, HODL, memes and NFT’s were the market buzz words in 2021 but fundamentals prevailed and equity indices in economies that weathered the pandemic better saw the best returns. Global stocks had a third year of double-digit gains +18.5%, as easy monetary policy, large fiscal stimulus and a quick roll out of vaccines and boosters supported the economic recovery. All global sectors saw gains with energy, tech and financials leading.
Developed Markets had strong gains, the US lead, with Europe close behind. These highly vaccinated economies were more resilient to slowdowns, inflation pressures fueled by the global supply-chain challenges and tightening monetary policy. Companies were largely able to pass on a rise in prices, as economic demand outpaced supply, benefiting from the reopening of the global economy. The three major U.S. indexes gained for the third-straight year, with the S&P 500 +27%, at record highs (70 times). Economic data has been strong, along with corporate earnings with a +45% earnings growth expectation for 2021. The MSCI Europe ex UK finished the year with a 16% gain, led by the Banks and Technology sectors, while Travel and Leisure underperformed, amid the disruption from COVID that brought some reinstated restrictions.
EM ended down for the year, weighed down by a strengthening US Dollar and MSCI China down 22%, with a regulatory crackdown that targeted education and tech. The outstanding performer was the UAE as economic reforms, easing of visa restrictions and higher oil prices led to the Abu Dhabi Index +76% and Dubai Index +32% in 2021. MSCI India performed well+26% as domestic demand weathered well the virus waves and lockdowns.
Economic and corporate earnings growth remains solid and in 2022 we expect mid single digit returns from DM and low teen returns from EM equities. The more muted gains will probably be accompanied by higher volatility with opposing forces of the virus variant spread countered by a world better equipped to deal with it. We would use any sell off to add to positions, but would in the near term maintain a neutral “wait and hold” stance. Within DM we continue to prefer the U.S. and within EM the UAE and India. Our focus this year would be on corporate margins with higher interest rates on the horizon and inflationary pressures specially labour adding to input costs.
Our preferred sectors are financials, healthcare and select tech sub sectors – semis, cloud, 5G, EVs, health tech and security. With the pandemic accelerating the global digital revolution, data analytics and AI adoption is increasingly important. The mega tech stocks were the top contributors to the S&P 500’s gain as their larger market caps made their share price rises more impactful. Microsoft and Apple, are valued at $2.5tn and $2.9tn, respectively. Tesla joined the trillion dollar club and vaccine makers Moderna and Pfizer led the healthcare rally. Financials should continue to do well as yields should rise in line with monetary tightening. Healthcare is both growth and defensive and a focus of increasing spend from individuals and government.
Written By:Maurice Gravier Chief Investment Officer, [email protected]
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Yes, we think it’s alright
Major concern or false alarm?
Heated by the sunshine of a vibrant recovery, the magic liquidity is evaporating, and turning into fog for investors. While growth remains robust, markets may not be ready for the new uncertainties around central banks, inflation and interest rates, to name a few. We are getting prepared to navigate tactically, in a year of ‘low visibility ahead’.Know More
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