A cursory look at the markets after the summer period gives a generally encouraging view: rising rates, well-bid risky assets, little volatility on most asset classes. All of this is consistent with a risk-on universe.
But Ibrahima Kobar, chief investment officer at Ostrum, is only prepared to go along with this up to a point. He stresses that the details are much more ambiguous, with signs of underlying nervousness accumulating.
“We note, for example, that it is the least risky stocks that drove the rally while the ‘value’ or cyclical stocks were penalised. This validates our conservative view of markets. Valuations are very demanding at a time when growth has peaked.”
He adds: “It is also interesting to note that economic data no longer surprises upwards, the reservoir of good surprises is exhausted, and so the support for the market.”
Good news priced in
His short-term outlook over the coming months is that the markets will likely remain on a tepid trend.
“Too much good news is already priced-in to justify strong bullish moves.”
Patrick Moonen, principal strategist at NN IP takes a similar line. “Several market drivers (earnings growth, leading indicators, monetary policy pulse, fiscal policy pulse in US), will pass or already have passed their peak this year.”
Like Kobar, he suspects 2022 will become more challenging for equity markets than 2021.
“In addition, 2022 will also be characterised by key political decisions with elections in France, Brazil, the mid-terms in the US and a possible third term for Xi Jinping. This will in all likelihood create more volatility.”
Despite the air of caution, Kobar does not think the strength of the recovery justifies a correction but argues that in the longer term, however, the end of the crisis is likely to be difficult.
“Signs of bottlenecks are growing and, more generally, the economy is already showing signs of overheating, especially in the US.
“At the same time, inflation is setting in. While the term stagflation may seem excessive, the trend is there. This development, while the big central banks, especially the Fed, have not even begun the normalisation of their monetary policy raises questions.”
Tancredi Cordero, chief executive of Kuros Associates, thinks a correction may indeed be on the cards. “We have revised our short term expectations and we believe that, unless central banks U-turn on their move to reverse money printing, equity markets are poised for a short term correction – particularly in the old economy segment of the market. Banks are trading at higher multiples than pre-pandemic levels with interest rates in the US lower than they were in January 2020.”
He adds: “Bank of America price to sales stands at 3.9 vs its 2.6 pre-pandemic levels and even with a small increase in their net interest margins, this discrepancy we don’t think is justified.”
Inflation fears
Moonen is keen not to over-play inflation fears – believing they are transitory. “A large part of the higher inflation is caused by temporary factors linked to the uneven re-opening of the economy which has created supply and demand imbalances for certain products (energy, semi-conductors, building material) and services.”
He adds: “Also the labour market is subject to these forces, leading to higher wages. However, for the time being we do not see an upward wage-price spiral. Inflation expectations remain well-anchored too.”
Central banks will pursue somewhat less accommodative policies, Moonen says and warns that you can never exclude a policy error (premature tightening), which he insists would indeed be badly received by financial markets.
“Currently there seems to be no unanimity at the governing council where hawks and doves are battling. At the same time Central Banks will tread very carefully and prepare markets well in advance of policy changes.”
Post-Covid environment
Notwithstanding a more bearish view on 2022 compared to 2021, Moonen stresses there is no need to panic.
“Although it is an uneven pattern with some countries maintaining mobility restrictions whilst others are well advancing on their easing path towards normalisation, the impact of covid seems to recede thanks to the availability of vaccines.”
He argues that this bodes well for economic growth staying at above average levels in 2022. “This will support corporate earnings. Currently earnings expectations for 2022 are with 7-8% at the low side taking into account the level of nominal growth expected next year.”
He adds: “Supply-chain bottlenecks are a source of uncertainty but we expect these to progressively resolve. Of course, companies will also face rising input costs and potentially higher taxes and it is uncertain to what extend they can reflect this in higher selling prices. This is likely to be industry or even company specific.”
However, it must be emphasised – Moonen says – that corporate margins are high and there exists a buffer to deal with rising input costs, especially if these are temporary.
Daniel Morris, chief market strategist at BNP Paribas Asset Management, agrees that supply chain bottlenecks continue to be a concern, not only in the US and Europe but also in China, where rising infection rates could yet lead to restrictions being re-imposed. “Contrary to expectations that the end of extraordinary unemployment benefits would lead to a pickup in employment, payroll growth remains weak.”
He adds: “Importantly, the sell-off in Treasury yields (particularly real yields) has picked up steam following the more-hawkish-than-expected Fed meeting. This will likely pose a challenge to high equity valuations.
“The net effect of all of this is that we remain modestly overweight equities, given that the fundamental backdrop is still positive (economic recovery, supportive central banks, strong earnings growth), but anticipate there may be better opportunities to add risk in the near future.”
Tristan Perrier, strategist and economist at Amundi, agrees with the view that 2022 will bring with it increased volatility and uncertainty however he suggests this volatility might come as soon as Q4 2021, notably if more data comes in support of the low growth high inflation thesis, at least over the short term.
“Disappointment regarding the size and details of the US stimulus package, or a combination of temporary economic slowdown and financial accidents in China are also risks to watch,” he says.
