US bond yields still haven’t reached the pain threshold when it comes to the economy and the stock markets. But their sharp rebound so far this year is one of the factors that has fuelled volatility among US stocks. After a difficult week for Wall Street, ten-year yields unsurprisingly declined late last week after briefly nearing 1.90%.
Italy’s presidential election is always unpredictable because of the way the voting process works, and this year will be a particularly high stakes ballot, since current prime minister Mario Draghi looks to be the favourite. Draghi managed to bring Italy out of crisis mode, mainly by introducing a number of structural reforms, and is highly respected in both Italy and Brussels. But if he steps down as prime minister, that could trigger uncertainty on the financial markets.
The German economy has been through a very rough patch, in large part because the manufacturing sector was hit hard by supply chain disruptions. But the latest indicator readings point to an improvement in sentiment. First, the ZEW Indicator of Economic Sentiment rose sharply and then the purchasing managers’ index came in better than expected, with a sharp rebound in both the manufacturing and services sectors.
USA: multiples are holding equities back
Last year was an exceptional one in many ways. Firstly, US equities gained 26.9% over the year, making 2021 their third-best year since the start of this millennium. More impressive still: the S&P 500 posted new all-time highs no fewer than 70 times last year – or around once every three trading days.
The question now is whether the stock markets can do as well again this year. To answer that question, we need to compare the current economic situation with the one 12 months ago. This time around, the picture is not quite as rosy. The economy remains solid, but the recovery is slowing.
For the past four months, economists have been gradually downgrading their GDP growth forecasts. We therefore don’t think that US companies will be able to deliver quite as many positive surprises this year. Investors won’t be able to rely on expanding multiples either: US equities are among the most expensive in the world, and the slow decline in multiples that began in 2021 should continue, especially as the Fed tightens its monetary policy.
That’s how things stand as the year gets off to a bumpy start. The sharp rise in long-term interest rates alongside lacklustre corporate earnings mean that valuations have dropped to more reasonable levels. US price/earnings ratios have fallen below 20x for the first time since early 2020. And investor sentiment indicators are now clearly back in very bear-
ish territory. But the situation is far from catastrophic.
The outlook for the US economy remains bright. Consumer spending has soared and the country is nearing full employment. What’s more, robust demand and inventory rebuilding should keep output above its long-run average. Lastly, for the first time in two years, it looks like the pandemic could finally be brought under control this spring.
Indexes have dropped sharply since early January, which means that there could soon be some good opportunities to increase exposure to the region. However, we will hold off until the end of the current earnings seasons, as there could still be some bad surprises in store for investors.
Emerging markets – the finger’s on the trigger
Emerging markets’ disappointing performance in 2021 was not triggered by the “taper tantrum” that investors had so feared, but by Beijing’s steadfast implementation of a zero-COVID strategy, its refusal to adopt stimulus measures in response to the economic downturn and its regulatory crackdown on the property and internet sectors.
We expect China’s GDP growth to slow further in the first part of 2022, since exports should cool off after two exceptional years and the country’s borders will likely remain closed for a while longer, given the patchy performance of China’s own vaccine.
That said, equity investors seem to have already priced in this gloomy outlook. At the start of last year, it looked like China would tighten its monetary policy in order to avoid an overly abrupt post-COVID rebound. However, given the recent economic slowdown, the priority now appears to be stabilising the economy through measures geared more towards supporting GDP growth.
This shift in policy stance was confirmed when the People’s Bank of China (PBoC) announced a first cut in the reserve requirement ratio for banks, marking a step towards a more accommodative approach. It’s interesting to note that the PBoC has taken the opposite path to most central banks in developed countries, which plan to start scaling back the support they’ve been providing to their economies.
As investors’ confidence in emerging market equities remains shaken, so we are maintaining our conservative view of this asset class. However, these stocks are trading at a discount to global equities, something that’s rarely been seen over the past few years. We therefore plan to “pull the trigger” as soon as we see signs of improvement, which should appear in the coming months.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
