On Wednesday, the Federal Reserve provided multiple indications that its run of ultra-easy policy since the beginning of the Covid-19 pandemic is coming to a close, speeding the tapering of their monthly asset purchases program and signaling three rate hikes next year, in response to rising inflation. Yet the markets reacted very positively. How to explain this “melt-up”? Will it last and does the Fed’s “hawkish pivot” have any implications for our market outlook?

While many economists have tried to compare the current macroeconomic landscape to that of the roaring 20s (optimistic scenario) or the 70s (pessimistic scenario), the context of the 40s is also rich in lessons.

Volatility made a comeback in the last few weeks, triggered by concerns that the US Federal Reserve could taper its monthly asset purchases at a faster rate and fears that the emergence of Omicron could weigh on global economic growth and contribute to supply chain disruptions. As we are heading towards a new year, we are concerned by the high level of valuations of some market segments (e.g. US equities) at the time of normalization of monetary policies. Moreover, some technical signals such as market breadth are pointing towards some negative divergence. That said, the weight of the evidence leads us to keep a positive stance on risk assets and equity in particular.

By most measures, 2021 will be remembered as an extraordinary year for global risk assets and the world economy. At the time of writing, stocks, home prices and cryptocurrencies are all at record levels while the price of energy, food and industrial metals keep rising. Meanwhile, US inflation is at a 30-year high while job openings and wages are surging.

We keep our positive stance on risk assets and equity in particular. In the near-term, we continue to believe that strong earnings growth will more than offset the coming gradual normalization in fiscal and monetary policy. - While monetary policies are becoming more uncertain and despite the fact that some of our technical indicators have deteriorated recently, equities are still the most attractive asset class given solid growth prospects, negative real bond yields, positive earnings momentum and favorable seasonality. - From a tactical standpoint, we are upgrading Japan equities from positive to preference and UK equities from cautious to positive. Both markets are attractively valued, are benefiting from positive macro momentum and are pro-cyclical in nature. - In light of ongoing inflationary pressures and monetary policy normalization, we see upward risks on long term rates and stay cautious on government bonds and spreads. - We remain cautious on commodities and stick to our (short-term) bullish view on the dollar. Our tactical asset allocation is summarized in the matrix at the end of the article.

“Slowbalisation”, which began even before the start of Covid-19, is a counter-trend to globalization. The pandemic could further accentuate this phenomenon.

We are reducing part of our overweight equity stance in light of a more uncertain liquidity environment and the deterioration of some of our technical indicators.