VERTIGO

KEY POINTS

• Investors have been scared by high valuations in the face of higher interest rates and geopolitical risk. Earnings have failed to soothe such vertigo.
• For the first time in a long time, we raise the allocation in fixed income and see selected opportunities in credit.
• Expected returns remain positive in equities. Cheap segments are the most attractive, but thematic stocks may also find their feet soon.
• Oil seems to be headed towards $100 and we stay invested for now as a hedge against tensions around Ukraine.

Both showed up_ When thinking about our 2022 outlook, we had identified two risks with both high likelihood and high impact: excessive Fed tightening and an escalation of tensions from Russia. We had not imagined that both would show up in just a few weeks. The market has logically taken a hit, but despair remains far off. How should we position after this brutal return to reality?

Out of the woods_ On the macro side, parts of the global economy are still in the midst of an Omicron wave. In the US, the pandemic has already taken its toll on activity in January. Recent surveys have come down and after controlling for population revisions, employment was most likely down last month. Estimates such as the Atlanta Fed’s GDPnow point to very low growth in Q1 after a bumper 7% gain in Q4. Still, our long-held view that we are basically out of the woods continues to hold. We do not expect the pandemic to meaningfully alter the recovery in 2022. As vaccination thresholds have now been reached and new treatments are coming to the market, the West is likely to transition to an endemic phase of the virus where activity restrictions will be increasingly mild and targeted.

Price pressure_ The main threat to growth over the medium term has in fact become inflation. In the US, despite rapid wage gains and job creations, real disposable income has fallen to zero. The combination of energy, durable goods and housing inflation is eating away purchasing power and threatening a stagnation of household consumption once excess savings from the pandemic has been used up. This is already evident in car sales which have logically softened given massive price increases (+40% for used cars). The housing market looks especially tight. Vacancy rates have fallen to their lowest point since the 1970s on supply constraints. Inflation should prove persistent on the real estate market.

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