Snapshot

Views at a glance - December


The pandemic is not over

Equity markets experienced their worst falls of the year as news emerged of Omicron, a Covid variant. While initial data suggests that Omicron is less dangerous than earlier forms of the virus, it is worrying that the new variant has spread so rapidly in South Africa, which has high levels of immunity as a result of previous Covid infection. This suggests that the new strain may be able to bypass immunity, whether from previous infection or vaccination, and that it is already present in many other countries. This could turn out to be a brief jitter for markets, as was the case with the delta variant, but it could have more significant implications. Markets are likely to remain volatile as new information emerges over the coming weeks.

Fiscal policy picks up the baton from central banks

Central banks in many developed markets have now embarked on the process of normalising monetary policy - and for now appear undeterred by Omicron. Fed Chair Jerome Powell even told Congress that current tapering plans, which will bring US quantitative easing to an end in mid-2022, could be accelerated. In the UK, interest rate rises will be very much on the agenda at the Bank of England’s mid-December meeting, even if they don’t actually happen until next year. More encouragingly for investors, political developments suggest that fiscal policy will remain supportive, even though it will provide less of a boost than in 2021. Joe Biden’s $1.7 trillion Build Back Better bill, focused on welfare and climate change spending, is slowly moving towards approval. In Germany, Olaf Scholz’s new coalition government has set out plans to increase spending on infrastructure and climate change measures.

COP26 a step in the right direction

COP26 failed in its overarching goal of securing emissions reductions that would limit temperature rises to 1.5 degrees. However, the event in Glasgow still provided some grounds for optimism. It resulted in pledges that should lead to a significant fall in emissions over the coming years. And governments have promised to review their 2030 targets before next year’s COP in Egypt, which could bring further commitments that get us closer to where we need to be. Additional momentum could also come from the recent spike in fossil fuel prices. It is a clear indication that the current pace of investment in renewable energy has not been enough to reduce our dependency on traditional forms of energy and that spending will need to accelerate.

Portfolio positioning

We are not yet taking any action in portfolios as a result of the Omicron variant. Given the uncertainty, we are not viewing this as a buying opportunity. However, it has not prompted us to lower our forecasts for economic and corporate earnings growth, both of which suggest maintaining exposure to equities. The economic uncertainty underscores the appeal of longer-term themes, such as energy transition, technology and healthcare. As we saw last year, these sectors can continue to do well even in the midst of a pandemic. It is also a reminder of the value of diversification within multi-asset portfolios and we continue to hold defensive and diversifying assets.

Outlook

At-A-Glance-EXPORTS-Icon-625x626.png Economics
  • Above trend global growth in 2021 and 2022
  • Growth supported by elevated consumer spending and increasing capex
  • Economic activity data has peaked but remains elevated particularly in the service sector
  • Moderating monetary and fiscal policy
At-A-Glance-VALUATION-Icon-625x626.png Valuations
  • Bonds remain expensive but can provide some defensive ballast
  • Equities are expensive relative to their own history, but need to be supported by earnings growth
  • Alternative assets including absolute return funds look relatively attractive as diversifiers
At-A-Glance-SENTIMENT-Icon-625x626.png Sentiment
  • Investors remain concerned about covid variants, persistently high inflation and threats to global growth
  • Sentiment indicators have moderated from extended levels
  • Volatility has picked up recently in response to Omicron concerns
At-A-Glance-RISKS-icon-625x626.png Risks
  • Risk of ‘stagflation’ i.e. slower growth, higher inflation
  • Risk of Omicron variant and vaccine efficacy concerns
  • Impact of slowing growth in China and potential for further regulatory intervention
  • Elevated asset valuations
  • Growing geopolitical tension (Ukraine, Taiwan, Iran)

 

Asset Classes

Equities At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Near term sentiment has been impacted by both rising Covid cases and vaccine efficacy concerns related to the Omicron variant, as well as continued uncertainty around the pace of central bank tapering. This could result in further periods of equity market volatility. Over the medium term, the expectation for above-trend growth and robust earnings should support markets. We maintain conviction in long-term secular themes including technology, healthcare and energy transition.
Bonds At-A-Glance-Status-Icons-NEGATIVE-50x50.png Longer-dated government bonds offer defensive characteristics given growth concerns. Valuations however remain expensive. We prefer USD and Chinese government bonds due to relatively higher yields and diversification benefits. We prefer corporate and inflation-linked bonds to conventional government bonds.
Alternatives At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Attractive diversification characteristics compared with equities and bonds. We favour absolute return strategies with the ability to deliver less correlated returns as well as real assets with long-dated visible revenue streams.
Cash At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Cash has defensive qualities in potentially volatile markets.

Equities

Equities At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Near-term sentiment has been impacted by both rising Covid cases and vaccine efficacy concerns related to the Omicron variant, as well as continued uncertainty around inflation and central bank reaction. This could result in further periods of equity market volatility. Over the medium-term the expectation for above-trend growth and robust earnings should support markets. We maintain conviction in long-term secular themes including technology and health care and energy transition.
UK At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Pressure on Bank of England to raise rates has increased, but the government has paved the way for increased spending on infrastructure as well as other areas. Valuations remain relatively attractive and we continue to see more opportunities within the domestic space.
Europe At-A-Glance-Status-Icons-NEUTRAL-50x50.png Tighter restrictions across Europe may impact consumer sentiment and spending which could have near-term growth implications. European earnings are relatively sensitive to a slowdown in China. Monetary policy continues to be accommodative whilst spending from the NextGeneration EU plan will be supportive.
North America At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Initial $1.9 trillion stimulus package has been passed and there remains the potential for further fiscal support. Economic activity remains robust and corporate capex could be supportive, although we are watchful of valuations which remain elevated.
Japan At-A-Glance-Status-Icons-NEUTRAL-50x50.png Restrictions remain relatively stringent which may suppress activity despite high levels of vaccination. Potential for fiscal support package in the new year and high savings rates could support the domestic economy.
Asia/
Emerging markets
At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Normalising Chinese growth and weakening credit impulse may have broader implications for the region. The risk of contagion from the Evergrande Group crisis continues to weigh on sentiment in the near term, although the central bank policy response will be supportive.

Bonds

Bonds At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Longer-dated government bonds offer defensive characteristics given growth concerns. Valuations however remain expensive. We prefer USD and Chinese government bonds due to relatively higher yields and diversification benefits. We prefer corporate and inflation-linked bonds to conventional government bonds.
Government bonds At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Long-dated government bonds provide some portfolio insurance characteristics, despite the risk of rising inflation. Chinese government bonds offer relatively more attractive real yields with lower volatility.
Investment grade At-A-Glance-Status-Icons-NEUTRAL-50x50.png We are mindful of company leverage, spreads below pre-Covid levels and absolute yields at close to all time lows. Opportunities within asset backed securities which offer a relatively attractive yield.
High-yield At-A-Glance-Status-Icons-NEUTRAL-50x50.png Spreads remain close to pre-Covid levels. Default rates remain supported by low cost of debt and expected positive economic growth in the short term.
Inflation-linked At-A-Glance-Status-Icons-POSITIVE-50x50.png We prefer US TIPS to conventional treasuries and UK linkers given the reduced cost of currency hedging. Inflation expectations have the potential to move higher in response to supply chain concerns and energy prices.
Emerging markets At-A-Glance-Status-Icons-NEUTRAL-50x50.png Emerging market bonds offer selective value across both US dollar and local currency debt. Idiosyncratic country risk remains diverse and a significant driver of returns.

Alternatives and cash

Alternatives At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Attractive diversification characteristics compared with equities and bonds. We favour absolute return strategies with the ability to deliver less correlated returns as well as real assets with long-dated visible revenue streams.
Absolute Return At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Selected opportunities in market-neutral strategies given increased stock dispersion and diversification characteristics.
Liquid private real assets At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Long-dated revenue streams and income characteristics remain attractive in select parts of the market. Within this space we see good opportunities in digital infrastructure and exposure to private companies.
Gold At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Gold is attractive as a diversifier given loose monetary policy and should provide portfolio insurance in the event of a meaningful equity market correction, or inflationary shock.
Short equity vol At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Offer attractive returns especially in times of heightened volatility, but we acknowledge the shorter-term correlation with equities.
Cash At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Cash has defensive qualities in potentially volatile markets.

Key

At-A-Glance-Status-Icons-POSITIVE-50x50.png Positive
At-A-Glance-Status-Icons-POSITIVE-NEUTRAL-50x50.png Positive/neutral
At-A-Glance-Status-Icons-NEUTRAL-50x50.png Neutral
At-A-Glance-Status-Icons-NEGATIVE-NEUTRAL-50x50.png Negative/neutral
At-A-Glance-Status-Icons-NEGATIVE-50x50.png Negative
At-A-Glance-Status-Icons-UP-50x50.png Up from last month
At-A-Glance-Status-Icons-DOWN-50x50.png Down from last month

 

Terms

Spread: the difference in yield between a non-government and government fixed income security.

Duration: approximate percentage change in the price of a bond for a 1% change in yield.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

All data contained within this document is sourced from Cazenove Capital unless otherwise stated.