Multi-asset outlook: Despite new risks, market has further to run
For equity investors, 2021 has been more than accommodating with global shares up 25% year-to-date. But despite September’s wobble, we expect the market has further to run, even if the balance of risk is less supportive than earlier this year.1
Looking ahead we believe growth should remain above trend in both 2021 and 2022, which will support company earnings, while the vaccine roll-out should also continue to bolster market sentiment.
However, as always, there are plenty of challenges for investors to contend with in the post-coronavirus world; if 2020 was the year of the pandemic, then 2021/2022 is the period of transition.
As well as having to navigate the continued emergence of COVID-19 clusters, the persistent backdrop of supply shortages has led to abnormally high levels of inflation – which has swiftly thrown the possible direction and speed of monetary policy into question.
In September, Federal Reserve Chair Jerome Powell warned that supply bottlenecks and hiring difficulties for employers could prove “more enduring than anticipated”, asserting that if prices remain elevated, the Fed would “certainly respond”.
The International Monetary Fund (IMF) recently cut its 2021 global economic outlook and now expects growth of 5.9%, 0.1 percentage points lower than its July forecast but it left its expectation of 4.9% growth in 2022 unchanged.
The IMF said the downward revision for this year “reflects a downgrade for advanced economies – in part due to supply disruptions – and for low-income developing countries”, largely due to the spread of the COVID-19 Delta variant.2
We believe the potential for decent economic expansion remains broadly sound, but the current set of market issues mean we have softened our overall outlook – lowering our 2021 global GDP forecast from 6.2% to 5.6% while we anticipate 4.3% in 2022.
On the back of persistent supply shortages, we have also cut our 2021 US growth outlook to 5.7% from 6.2% and expect 2022 to see 3.9%.
In the euro area, almost three quarters of the population has been vaccinated, while economic activity benefitted from solid momentum in both the second and third quarter (Q3). As a result, we now anticipate the trading bloc will achieve 4.7% growth in 2021 and 3.9% next year.
However emerging markets are having a tougher time, as the Delta variant has proved to be a major hurdle and we expect aggregate GDP growth of 5.9% in 2021, and 4.6% in 2022.
A resurgence of coronavirus cases, mobility restrictions, power shortages and flooding have weighed on China’s economic output in recent months, while investors have also been spooked by recent difficulties in the country’s property sector.
Nonetheless China’s economic growth has continued to outpace other markets in the third quarter (Q3) but the speed of the recovery has slowed - GDP rose 4.9% year-on-year compared to 7.9% in Q2, and below a consensus forecast of 5.2%. Looking ahead we anticipate 7.9% growth for the world’s second-largest economy in 2021, falling to 5.5% in 2022, with downside risk.
The annual rate of US inflation hit a 13-year high in September at 5.4% - up from 5.3% in August.3 We anticipate that this backdrop of persistently high US inflation will endure above the 4% mark before falling back sometime at the end of Q1 next year. We also forecast that euro area inflation will remain close to 3% until the end of Q2 2022, before starting to ease thereafter, as supply chain problems recede, and demand normalises.
However, when price increases start moderating, we believe they will remain relatively high compared to what prevailed between 2014 and 2020. Going forward there are numerous factors that should keep inflation higher including a notable increase in living costs such as rent.
In addition, wage growth is accelerating due to labour shortages while some bottlenecks, for instance in the semiconductor market, are likely to take more time than expected to be resolved. The focus on transitioning to a lower carbon world could also the push prices of some raw materials higher, a trend we have already witnessed in the commodities market while the rotation of China’s growth model - from exporting to consuming - should impact prices. Below we look at our main asset class views for the medium term.
Forward looking: Five-year average annual forecasts4
Fixed income outlook
While shares have enjoyed a strong run so far in 2021, the environment has been less rewarding for fixed income holders with government bond returns essentially flatlining, given the paltry -1% year-to-date return. However, high-yield investors have fared much better with 7%.5
As things stand, in our view all the main factors – including inflation expectations - are pointing at further upward pressure on yields. In addition, short-term rate expectations are likely to reprice further on the upside. Presently, the market is pricing in the Fed to deliver six 25 basis points (bps) hikes by the end 2025, which we believe is too low given where we believe growth and inflation are likely to be. Moreover, substantial public infrastructure investments are likely to lift the US economy’s total productivity and potential growth, thus allowing for structurally higher short-term rates.
In addition, the tapering of the Fed’s asset purchase programme will shift the dynamics of government bond demand and supply, removing the lid on the term premium. Higher uncertainty around inflation should also lead to higher risk premium. Therefore, on a three-year basis, we see yields rising further from here, reaching 2.5% for 10-year US Treasuries and 0.7% for 10-year German bunds – and yields have already started to edge higher after moving lower in early summer.
In terms of corporate bonds, we expect very low spreads - the yield differential between bonds - to persist into 2022. In the investment grade sector valuations are no longer attractive due to the tight spreads. A slower summer primary issuance calendar, very low default rates, strong earnings growth, and high level of cash on corporate balance sheets are underpinning current market levels.
We maintain an average target at 120bps for European investment grade (IG) credit spreads and 150bps for US investment grade credit spreads, not far from current levels and low compared to historical standards. Volatility has raised its head in the high yield sector as credit quality has subsided because of new names coming to market at discounted levels, while the Asian market has been hit by the trouble surrounding the heavily indebted property giant Evergrande, albeit with no signs of contagion so far.
Three-year target bond yield forecast6
|10-year US Treasuries||2.5%|
We are presently more positive on equities than we are on fixed income, even if we believe investors should be ready for volatility to make an unwelcome return as the world re-adjusts post-pandemic and central banks tighten monetary policy. We have already witnessed a pickup in volatility across equities and fixed income in September. Since the start of May, the VIX volatility index averaged 18.4, below its one-year average of 21.5 but implied volatility has climbed above the 20 level several times since May – we believe the current range of the VIX is circa 16 to 24.7 Economic activity looks like it has peaked and is struggling with prolonged supply chain disruption, which is adding to the inflationary pressures.
In addition, valuations are high on an absolute basis, although multiples are easing as earnings sharply grow. For now, we believe the environment remains favourable for equities. We like ‘low-duration’ sectors, i.e. those that are not sensitive to bond yields such as banks, which should benefit as yields rise. We also favour those companies in sectors which are reopening – travel, retail, beverages and airlines too, despite some continuing travel restrictions. Over the medium term, as policy rates rise in the US, valuation multiples are expected to contract by 10% over five years, shaving roughly 2% off equity returns per annum. Given our 5.5% earnings per share growth per year expectation and 2% dividend yield, we therefore expect a total return of around 5.5% per year over the coming three to five years for US equities.
Total return annualised forecast over coming three to five years8
Monetary policy normalisation has officially begun. New Zealand raised its interest rates for the first time in seven years in September in a bid to tackle higher inflation and soaring property prices. Poland also unexpectedly raised its benchmark interest rate as inflation there recently hit a 20-year high. Elsewhere Norway, South Korea and the Czech Republic have also increased their borrowing costs in the past few months as they start to unwind emergency measures put in place during the pandemic. It is expected that the Bank of England will also likely raise rates by the end of 2021.
The bounce enjoyed in growth, prices and labour markets will justify normalising monetary policy where inflation was already at target and overheating is a risk – and it is this sentiment which is currently driving currency markets. The Fed very much falls into this category and the main driver of support for the US dollar has switched from asset purchase programme tapering expectations, to the more direct and powerful driver of the rising interest rate differential. We expect some additional strength for the greenback as US Treasury yields rise further, waning technical excess liquidity as the debt ceiling should get extended in December and additional growth impulse being secured as President Joe Biden’s ‘Build Back Better’ fiscal package gets voted in.
With bond yields still very low, their capacity to diversify and protect portfolios is naturally reduced, which make them less desirable from a risk perspective. US dollar exposure, often viewed as a so-called ‘safe haven’ during periods of uncertainty, will likely help non-US investors during risk-off episodes, in terms of portfolio protection.
Overall, we are confident the global economic recovery will spill into 2022 but we are very aware of the present supply side issues plaguing markets and we expect this to certainly continue to disrupt economic data and asset class performance in the short term. Monetary policy normalisation and higher inflation will be the key drivers for markets in the coming years. In this context, we expect equities to continue to outperform bonds. However, volatility is likely to be structurally higher, making diversification absolutely key.
 FactSet, data as at 21/10/2021 (euro terms)
 World Economic Outlook, October 2021 (imf.org)
 United States Inflation Rate | 2021 Data | 2022 Forecast | 1914-2020 Historical (tradingeconomics.com)
 AXA IM as at October 2021
 FactSet, data as at 21/10/2021 (euro terms) JP Morgan Global Government Bond Index / ML Global High Yield Index
 AXA IM as at October 2021
 2021-09-monthly-investment-strategy_en_1 (1).pdf AXA IM
 AXA IM as at October 2021
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