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Uncertainty around the pandemic lingers. Many countries that claimed victory a few months ago got confronted with new corona outbreaks. Yet, notwithstanding that such resurgences get high news coverage and lots of airtime, aggregate confidence that we are winning the war is on the upside. Global cases over the past two weeks have started to roll-over. 5.5 billion people received at least one vaccination shot. Countries with high vaccination rates get comfort by tepid increases in hospitalisations. Excess mortality rates start to align with pre-pandemic times. Before long, we all sense that the key and potentially final test is ahead of us. The northern hemisphere autumn and winter 2021 – 2022 will be the episode that quenches the pandemic for good or catapults us in extra COVID-19 times.
Equity markets are priced for good times ahead and focus on the conditions in a post pandemic world. Fixed income markets hold an arm behind the back, as always. Investors have embraced this barbell approach over the summer, accumulating DM equity as well as maintaining exposure to quality DM rates and credit markets. Exposure to EM equity and bond sectors got reduced. It is as if the pandemic in DM economies will come to a standstill and EM labelled investments should be avoided given the lack of progress in fighting COVID-19.
Central banks and governments are aware of the potential imbalances across outcomes and continue to pull the accommodative set of cards as we stumble towards the exit. Markets are confident that we will find the exit, sooner rather than later. Science, however, is more sanguine and weighs probabilities based on vaccination progress across DM and EM countries. The scientific approach might have called for less buoyance in equity markets. What are economic indicators, leading or lagging, conveying?
Well first and foremost, volatility in key indicators from inflation to growth and employment has been high. Pre-pandemic standard deviations have all shot up by several notches over the past year and a half. Point in case was last Friday’s US non-farm payrolls posting +234k numbers for an almost 500k miss versus consensus estimates. Clearly, the whole economic data ecosystem has been an engine of noise rather than an economic cycle guide. Since April 2020, the wisdom of crowds has been farsighted, focusing on positive outcomes over the long haul; A rare condition. The lift in risk assets has gone hand in hand with ballooning central bank balance sheets. There is a good chance that a protracted 2022 FED taper will put the brakes on equity and parts of credit markets. FED chair Powell pulled off a remarkable result, as he disconnected conditions for taper i.e. progress in achieving 2% inflation or just above over the medium term from conditions that need to be fulfilled in order to start a rate hiking cycle i.e. maximum sustainable employment. US inflation is set to revisit the targeted 2% to 2.5% range by end of 2022. Maximum employment, a complex target encompassing minorities and less-educated workers, might only be reached by 2024 at best. The US Treasury market is in the first innings of pricing a late and protracted hiking cycle. In his Jackson Hole speech Powell reiterated the lasting presence of global deflationary forces that never disappeared from technology, digitisation and bad demographics. One should add inequality as a force that keeps rates low for longer. Indeed, savings rates of the 10% top earners are factors 3 to 5 times higher than the middle 40% or the bottom 50%.
So, what did this summer reveal? DM rates recaptured a downward bias. Equity markets powered ahead, led by strength in quality-growth names across the US and Europe, reaching for new record highs. In stark contrast, we witnessed Chinese tech stocks getting pummelled anew as the communist party tightened its grip. They steer on a macro-level, fostering ‘common prosperity’. The Chinese stock slump is treated as an idiosyncratic event. Again. Most market shocks get that label as central banks liquidity provisioning is a medicine that cures all evils. Indeed, since the end of 2008, QE has changed valuation equations and the signal ability of markets.
So far, 2021 has been a year where traditional investment profiles saw blockbuster returns. The rate scare over the first quarter was short-lived. The FED staged a highly convincing communication performance. Bond managers across the globe embraced the transitory inflation narrative. From defensive over balanced up to dynamic portfolios, 2021 is on track to become a blockbuster year. With defensive portfolios delivering 4%+ returns, we watch balanced profiles attempting to cross the 10% barrier. Dynamic profiles steam ahead, posting 14%+ results. A lesson over 2021 reminds us of the adagio that time in the market easily beats timing the market. Knocking in another open window that deserves to be repeated is that global diversification across equity and bond sectors pays off.