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.

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.

18 months into the Covid pandemic, the world economy has experienced its shortest yet deepest recession ever, followed by one of the strongest recoveries on record, thanks to historic levels of government and central bank support. The magnitude of the shock, and the uncertainties around its impact on the economic outlook, meant financial markets oscillated between despair and hope, with occasional spikes in both directions. Europe’s summer marks another step in this atypical economic cycle with a transition from recovery to an environment of steadier growth.

The ongoing global recovery is very strong. World economic growth this year will be the highest in at least four decades as economies recover from 2020’s huge shock. Evidence of this spectacular recovery already widespread, especially in the United States, which is once again leading the global economy thanks to fiscal stimulus and a swift and successful vaccine campaign. The reopening of business activity has unleashed record pent-up demand. Europe is also about to experience a similar boost as it gradually lifts pandemic- related restrictions.

The global economic recovery continued through March with more evidence of improving industrial activity and commerce. US retail sales recorded their second-largest rise in since 1992, and manufacturing expanded by an almost four-decade high. Positive economic developments saw markets pricing in a return of inflation. Even the external shock of Archegos Capital Management’s stock sell-off late in the month was most notable in its failure to disrupt markets structurally. Rising US treasury yields, reflecting expectations that interest rates would respond to the accelerating recovery, were contained by the Federal Reserve’s communications. The US central bank reminded investors that it is focused on the real economy, jobless rates and average inflation targeting and sees no reason to raise rates before 2023.

When fear grips investors, the market can appear to be full of phantoms and poltergeists. As an explosive 2021 reaches another volatile cross-roads, investors have a lot to contend with – spiking treasury yields, ructions in the tech market, and a yet unresolved global pandemic. In times of upheaval or economic disruption, investors, directed by deep-wired psychological conditioning, are often led to exaggerate and extrapolate trends for future events. On the current extreme pole of anxiety, some investors are concerned newly elected President Biden’s fiscal largess could unleash the dreaded return of proper inflation in the West’s foremost economic stronghold.

Staggering spikes in Covid-19 cases, all too expected Brexit disruptions and shocking anti-democratic developments in the US kicked off 2021 with a bang. From a different vantage point, however, the beginning of 2021 can be seen as positive. Vaccines roll-outs are bringing us closer to the end of the pandemic, uncertainty around Brexit is over and a Democrat majority in the US Senate will enable enhanced fiscal support.