Investment Strategy - The next chapter
The investment story of 2021 has been remarkably positive, against a backdrop of a pandemic where the arrival of vaccinations and the exiting of lockdowns introduced a strong recovery. But the impetus from opening-up was not expected to last forever. And the pandemic, while tamed, has not disappeared. The extraordinary growth from economies reopening is now moderating. China and the US are already showing signs of slowing down, while Europe is still on an upward reopening curve.
ABN AMRO believes that the peak in terms of global economic growth has been reached. We are now beginning to see changes that will lead to a new chapter in markets. We expect that economic growth will diminish, but remain strong and above trend through next year. This new chapter also includes the US Federal Reserve beginning to carefully indicate a tapering of its support for financial markets and the waning impact of the huge amount of fiscal stimulus the US pumped into its economy. At the same time, the impact of a slowdown in China may be felt in Europe.
As these shifts occur, the case for risky assets, such as stocks, remains in place. The drivers of equity markets, while weakened in comparison to the peak of the recovery, are set to remain strong. The ABN AMRO Investment Committee made no change to the asset allocation at its latest meeting. Stocks (overweight) continue to be favoured while bonds are underweight.
Stocks remain in favor
Stocks have had surprisingly good returns so far in 2021, despite adverse circumstances and uncertainties. US stocks (as measured by the MSCI US) have returned 18.7% year to date and European stocks (measured by the MSCI Europe) have posted 17.1%. Of course, it has not been a straight line up, but, in general, the market has been resilient – quickly recovering after push backs and inflation fears.
Earnings are expected to remain supportive in the following months, but earnings momentum is likely to lose some steam. This is owing to the expected loss of economic momentum and cost pressures that have arisen due to supply-chain issues. The shortage of semiconductor chips, for example, could take months to resolve, but it is not expected to derail the recovery.
A sign of increased uncertainty is market divergence. Developed markets, for example, have performed well this year, while emerging markets lag. The latter being affected by China’s slowdown and lower vaccination rates. And, in the US, the S&P 500 Index, dominated by IT and health care, has risen, while the more value-oriented Russell Index has traded sideways.
Underlying shifts increase uncertainty
There are other shifts underway as the world transitions back to an environment that is closer to what is regarded as normal. As economies recovered, manufacturing surged, but is now slowing, as growth shifts to services, where indicators are still strong and accelerating. Economic surprises are also on track to become less positive.
The prospect of monetary policy tightening has also gripped markets. By whispering about tapering and being a bit more hawkish than expected, the Fed has created uncertainty as it clears the way for post-pandemic normalisation. Given that the US central bank believes that current inflation pressure is transitory, the path back to a more normal interest rate environment will be extremely slow. In general, we do not believe that the tapering of the Fed’s accommodative monetary policies – likely to occur next year -- will be a significant market event.
And, finally, there is the lessened but unresolved risk of the coronavirus and its variants. While new lockdowns are not expected, the delta variant could delay a rebound in consumption in some countries. Daily new infections have largely moved sideways in the eurozone, but infections are increasing in the US, where it is denting consumer confidence. For those countries where vaccinations are well underway, we do not expect there will be additional restrictions.
Conclusion
In the midst of these transitions, the stock market remains robust; and economic growth, while diminished, is expected to be stable and above trend through 2022. Remaining concerns, including those related to the pandemic and inflation, have led to increased market volatility. Nonetheless, it remains an obviously attractive environment for risky assets. But as we move further away from the peak of the recovery, it becomes increasingly important to use a diversified portfolio to spread risks and to keep an eye on the changes that economies and markets are undergoing as the boom of the recovery fades.
Richard de Groot
Chair ABN AMRO Investment Committee