Rising, but manageable, risks

29/09/2021 • 3 minute read

Richard de Groot

It has been a tumultuous time since 31 December 2019, when the World Health Organisation was first alerted to the virus now known as Covid-19. Since then, investors have experienced a global pandemic, lockdowns, economic recession, vaccine success and a recovery that went further and faster than expected. And this whole trajectory arrived as a surprise to markets and the world.

We are now returning to a more normal environment. While scientists believe that the coronavirus and its variants will remain with us, there are strategies to manage it. For investors, more normal worries are also returning, such as the next steps of central banks and the effect of a slowdown in China. But even as investment risks increase, we believe that they are manageable.

The ABN AMRO Investment Committee made no change to the asset allocation at its latest meeting. Even as momentum slows around the world, risky assets, such as stocks, continue to be supported. ABN AMRO continues to favour stocks (overweight) over bonds (underweight).

Still positive outlook for equities

The environment for stocks remains positive, but diminished. We expect that the world economy is going to normalise in coming quarters, but will remain above trend. In turn, corporate earnings expectations are likely to deteriorate. While we expect earnings momentum to remain positive, it will be dented by the economic slowdown and cost pressures. At the same time, the US Federal Reserve and the European Central Bank are beginning to reduce some of their very accommodative monetary policies. The combination of the loss in momentum and less supportive central banks will likely generate higher market volatility.

Resilient markets

Most recently, the suspension of interest payments by a huge Chinese real estate conglomerate, China Evergrande Group, jolted markets. We expect that Evergrande’s troubles will be carefully managed by the Chinese government to limit the effects on the financial and property markets. The global market’s reaction to Evergrande has so far been a picture of resilience. Once again, bad news was absorbed, markets had a brief negative reaction and then moved on.

Neutral stance toward equity regions

The equity asset allocation calls for a neutral stance toward the US, Europe and emerging markets. Emerging markets have had a period of underperformance. But given the effects of a slowdown in China and the Federal Reserve’s monetary policy tightening, we do not see the decline as a buying opportunity. We also prefer to continue to take a neutral stance toward developed markets. The US economy is slowing; and even though Europe is still in recovery mode, it has more exposure to China than the US.

Bond markets offer little opportunity

The situation for bond investors remains challenging. Government bonds with negative yields detract from performance and offer little in terms of their traditional role as a portfolio buffer in hard times. Returns must be sought in the higher-return and more risky segments of the fixed income market. As such, we continue to prefer investment-grade corporate bonds, high-yield bonds and emerging-markets debt

Conclusion

Investment risks are rising, but we retain our faith in risky assets, as the risks we see are manageable. There is also no sign of recession and central banks will continue to be vigilant and to safeguard the recovery. Lessons were learned in the aftermath of the 2007 financial crisis. Central banks will not make any sudden moves. Most recently, the Fed communicated that they may begin reducing bond purchases as early as the end of this year. Markets absorbed this news with little disruption.

We do not expect a first US rate hike until 2023. Inflation, while more ‘’sticky” than expected is still believed to be temporary. Above-trend global growth continues to be expected through 2022. This is despite our recent downgrade of Chinese economic growth from 9.0 to 8.3% for 2021.

As we enter this next market chapter, we expect volatility to increase. This also means that the possibility of a serious correction rises, given uncertainty regarding what’s next and the very good performance seen over the past year or so. If the correction is significant, it could provide a buying opportunity for stock investors. But it will be important to use diversification to spread risks and to be cautious as markets and society adjust to the post-pandemic world.

Richard de Groot, Chair, ABN AMRO Investment Committee