Investment Outlook – A time of transition

The global economy is suffering from a series of significant economic shocks at a time when some segments of the market are quite expensive based on lofty expectations of long-term growth. While many of these risks have been building up for weeks, the credit crisis in China and rising energy prices seem to have temporarily burst the bubble of optimism. The global economy is indeed showing signs of losing steam and faster than was expected, especially in China. Meanwhile, inflation is an issue that is belatedly being addressed in advanced economies. However, this period of volatility opens the way to better entry levels as the economic outlook should eventually prove to be very conducive to risk taking. Liquidity simply remains ample and is, for now, sloshing around to wash away our fears.
1. A series of economic shocks
The global economy is slowing down at a more rapid pace than expected as inflation stays elevated creating what some call “a stagflation scenario” defined as stagnant growth (not the case) combined with elevated inflation. The main reason behind this is that the global economy recovered much faster than expected last year leading prices to overshoot thanks to higher wages for low skilled workers, disruptions in the supply chain and excessive demand for some commodities such as natural gas. Some of this inflation is seen as transitory due to bottlenecks and pent-up demand, while some is considered more lasting, forcing the Federal Reserve to move towards tapering while the European Central Bank is only gently reducing the pace of its bond purchases. The major unexpected shock is coming from China whose growth was gently decelerating from elevated levels. There, the willingness of the authorities to confront excessive leverage especially in the real estate industry seems to has led to a moment of reckoning in this economically crucial sector. It was built on expectations of a perpetual race upward in wealth and growth. Comparisons are now being made between Evergrande’s demise and the collapse Lehman Brothers–although many analysts dismiss this comparison. The reality is that it will take weeks to understand Evergrande’s impact on growth in light of its impact on the real estate market.

2. Outlook for growth and inflation
The market will eventually price in this more rapid slowdown in global growth led by China. It will take more time to price the transitory nature of the inflationary shock we are currently suffering, indeed natural gas prices will likely be higher this winter and OPEC+ has every incentive to maintain high oil prices during the transition to green sources. As the global economy slows down, the market will be faced with the fact that the pace of Fed tapering still leaves ample liquidity uninvested and more fiscal impulses from the United States to (eventually) China and the EU. Over time, optimism should steadily trickle back into the market fed by the enormous amount of liquidity sloshing around and very decent growth prospects. Till then, we must negotiate the US budget ceiling through reconciliation.

3. Market implications
This reckoning with reality should come and eventual pass leaving us with a rather solid pace of growth in advanced economies. Nonetheless, it is a reminder that at the end of the day it is important to feel confident about what you hold. That implies a focus on the secular forces of ESG, the safety of Covered Bonds and the flexibility of multi-asset solutions.
The current volatility in global equity markets should eventually ebb away as excess liquidity pushes again the buy on dip mentality. That leaves the market to return to trending on some styles and products such as growth, quality and North American equities. But ever more important, investors should focus on the secular forces that will drive markets in the coming decades – namely climate change.


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