Peaks and pitfalls

The coronavirus is tamed, but not completely defeated; and some of the effects of lockdowns are taking longer to exit from than expected. Central bank monetary policies and government stimulus programmes are also being unwound. Nonetheless, financial conditions remain generous and interest rates are expected to be low for some time to come. Monetary and fiscal authorities will continue to guard growth, which we expect to be above long-term historical averages through next year.

Stock markets have been volatile but resilient in 2021. Developed markets have risen by around 20%, while emerging markets have significantly lagged. Bond markets are, in general, difficult. Core government bonds have had negative yields for some time, and therefore no longer offer a buffer to investor portfolios in tough times. Even cash is problematic, given very low or negative savings rates.

In this environment, the ABN AMRO Investment Committee continues to prefer stocks (overweight) over bonds (underweight.) At its latest meeting the decision was made to add exposure to alternatives (overweight) in place of some cash in the more defensive-oriented portfolios. Exposure to alternatives is being introduced using a combination of hedge funds employing different strategies with an expected net return that is higher than the return on cash or that of negative yielding bonds.

As the economy slows, the chief worries are inflation & energy prices, China’s slowdown and the supply bottlenecks that are hurting production and driving up producer prices. We believe that these risks are manageable and mostly temporary. 

Regarding inflation, ABN AMRO expects that the peak is close-by in terms of global inflation. The US is closer to its peak, while in Europe it is probably still a couple months away. In general, we believe that inflation will start declining over the next year, but it will stay somewhat higher than we had first expected.

The recovery, although slowing down, continues. Energy prices in Europe have been a shock and are weighing on growth, certainly compared to six months ago. But the large number of unfilled manufacturing orders will continue to support production and the economy. Regarding China, we expect it to get better from here, with the third quarter having been the worst in terms of economic growth. Supply bottlenecks should also ease over time, even though complete normalisation could take a year.

Market sentiment for stocks remains strong. Developed market performance has been excellent and the fear of missing out has driven inflows. Most recently, however, some decline in enthusiasm has been seen among retail investors. With the peak of economic growth having been reached, so has the peak in earnings growth. Earnings momentum is deteriorating, but we expect it to stabilise in coming months.

Over the last few weeks, the energy sector has outperformed, based on rising energy prices. The information technology and financials sectors have also done well. We believe that if economic and inflation uncertainties resolve, markets could continue to track upwards although most likely in a more volatile environment.

The combination of negative yields and the prospect of inflation has hurt bond markets. Positive returns in more risky bond segments are still possible, although risks are rising. We continue to prefer investment-grade corporate bonds, high-yield bonds and emerging-markets debt.

Strategies offered by alternative investments can add new sources of return and diversification to investment portfolios. The decision to divert some cash to diverse hedge fund strategies was undertaken to add opportunities for return outside traditional stock and bond strategies. Long/short strategies, for example, can discover mispricing situations in both equity and fixed income markets. These strategies often work best in volatile markets and offer an improvement over returns from cash.  

We are still operating in a not-yet-normal world, but it is certainly coming closer. Markets have already accepted and priced-in the next steps of central banks. Less accommodative monetary policies are also a clear indication that central bankers are more fearful of too much stimulus than a backslide in the recovery. Actual rate hikes from the European Central Bank and the US Federal Reserve remain far away, however. We continue to believe that stocks are the engine of portfolio performance, although return expectations are diminishing.

Richard de Groot
Chair ABN AMRO Investment Committee