#Articles — 13.12.2021

Investment Strategy Focus: December 2021

Edmund Shing, Global Chief Investment Officer


  1. It is natural to see stock investors taking some money off the table, following the excellent performance and huge equity fund inflows since November 2020. This does not imply a lengthy correction or bear market upon the emergence of the new Omicron COVID-19 variant.
  2. Q4 growth to benefit from easing of supply chain bottlenecks: with semiconductor production ramping up and sea freight rates now falling substantially, manufacturing production should recover quickly this quarter and beyond. Good news for 2022 growth and employment.
    1. Watching for a move from Expansion to Overheating: we monitor a number of key indicators closely, including the high yield spread, for signs of a shift from the reflation stage to the overheating/peak stage of the cycle.  For now, we remain in expansion/reflation, good for equities and real assets.
    2. Now forecasting EUR/USD stability: we now expect the Fed to stick to its announced tapering plan, and decide a first interest rate hike in July 2022 (Q4 2022 expected previously). We now also forecast three 25bp rate hikes in 2022. We thus forecast EUR/USD at USD1.12 in both 3 and 12 months from now.
    3. Long-term expected returns updated: we have updated our long-term expected returns by asset class. Over the next 10 years, average expected equity market returns range from 5.5%-7.25%, sovereign bonds 0.25%-1.50%, investment-grade credit 0.75%-2.00% and cash 0.0-1.0%. Highest returns are expected from Private Equity, then Emerging Market and UK equities.

What to do when volatility spikes

Volatility is normal even during bull markets

Stock markets are now correcting, but this is not unusual. In fact what is unusual is that the stock market has gone up for so long without a meaningful correction of at least 10% over the last year. In normal times the stock market sees a correction of at least 10% at least once a year on average, even during a bull market. So, this recent period since October 2020 has been somewhat unusual to say the least, with not even a 5% correction.

This risk-off move may be exaggerated because:
a) investors have done very well out of the stock market advance and may want to take some profits off the table at the first sign of weakness; and
b) that fund flows into equity funds have been monstrous in the US. According to fund flow data provider EPFR, the inflows into stock funds in the US this year are bigger than in the last 19 years, cumulatively. In other words, a massive inflow into stock funds following the strong momentum in stock funds, and of course, aided by the lack of yield available in bonds and in cash today.

A new Omicron (B1.1.529) COVID-19 variant in South Africa: relatively little is known about this variant for now. Bear in mind that only 23% of people in South Africa have been vaccinated. Secondly, this new variant seems to be very infectious and is now the dominant COVID variant in South Africa. Thirdly, some random cases have spread to certain European countries like Belgium, the Netherlands and the UK.

We do not know how resistant the current vaccines are against this new variant. Clearly the concern for investors is that the vaccines will be less effective against this variant than against the existing variants. And thus, that this may exacerbate the fifth infection wave that we are currently seeing in Europe.

The threshold for renewed lockdowns is extremely high, given widespread household fatigue over repeated COVID-19 lockdowns. I believe that with the arrival of new treatments from both Pfizer and Merck which have proven to be very successful in limiting hospitalisations. Bottom line: we need more hard data before we can assess the true risk from this new variant.


It is natural to see stock investors reacting in a knee-jerk fashion to take some money off the table, following the excellent performance and huge equity fund inflows since November 2020. This does not mean, however, that we are about to enter a lengthy correction or even a bear market which would necessitate changing our equity recommendation from positive to neutral or even negative.

The Big Picture

Concerns rise over COVID-19 5th wave

Potential for further COVID-19 disruptions short-term: while Q4 growth forecasts pencil in a sharp rebound following a Q3 hit by widespread supply chain disruptions to production and consumption, the spread of a 5th COVID-19 wave in Europe could put these optimistic forecasts at risk.

Germany is at the epicentre of this new wave of infections despite 70% of its population being vaccinated, with almost 50,000 new Coronavirus infections per day, far more than the previous two infection peaks. Neighbouring Austria has already enacted a new lockdown, fuelling fears that Germany and other countries may follow suit.

Note that Germany is not typical in its infection profile – France and Sweden do not have the same huge surge in new infections, due to the acquired natural immunity in their populations from previous infection waves.   The eurozone is still forecast Q4 GDP growth of close to 5% annualised by the consensus, while German consensus Q4 growth forecasts have already been cut dramatically to 2.2%. Europe may see short-term weakness in consumption on the back of COVID-19, but we do not see a longer-term impact on growth.

Q4 growth helped by supply chain easing

Nevertheless, Q4 is expected to see a huge rebound in growth: after a Q3 slowdown held back by supply chain disruptions, Q4 growth is expected to rebound strongly. The Atlanta Fed nowcast indicator points to 8.3% annualised US GDP growth for this quarter. 

There are preliminary signs of easing in supply chain bottlenecks, with Malaysian chipmakers back to 100% output, signs of easing congestion in US ports, lower freight costs, and carmaker Toyota setting a December production target even above pre-pandemic levels.

Inventory rebuild, consumption rebound: economic growth should start to reaccelerate from this quarter (Q4) into 2022, as manufacturers are able to produce goods such as cars and mobile phones, and companies can rebuild inventories which have fallen to near-record lows. Construction could also deliver a big boost to economic growth. US housing starts have slowed significantly due to shortage of key materials such as lumber. In contrast, the number of authorisations continues to climb, underlining the growing pipeline of housebuilding projects waiting for available supplies, and for labour shortages to ease.


European COVID-19 resurgence could dampen near-term growth: but with the arrival of effective COVID-19 treatments from Pfizer and Merck, the Coronavirus is becoming endemic rather than epidemic, something we will have to live with. With semiconductor production ramping up and sea freight rates now falling substantially, manufacturing production should recover quickly this quarter and beyond.

Macro Risk Management

What does well when? Defining 4 key phases of the business cycle

We define the four stages of the business cycle as:

  1. Recovery (growth ↑, inflation ↓): Growth booms as the economy is restarted. Inflation falls as a result of consumer and central bank behaviour in recessions (end of previous cycle).
  2. Reflation/Expansion (growth ↑, inflation ↑): The economy enters a sustainable growth period, triggering inflation. Central banks begin a new rate hike cycle.
  3. Overheating/Peak (growth ↓, inflation ↑): Growth slows and inflation increases further with full employment. Central banks continue to raise rates.
  4. Recession (growth ↓, inflation ↓): Growth is negative and inflation falls, given reduced consumer spending and rate cuts by central banks.

During 2020-21, we have clearly passed from Stage 4 (Recession) to Stage 1 (Recovery), and then to Stage 2 (Expansion), with above-trend growth now accompanied by rising inflation.

What assets typically perform best at each stage?

  1. Recovery: Aggressive risk-on positioning - Equities (particularly small value stocks), real estate, oil.
  2. Reflation/Expansion: Risk-on - Equities (quality stocks), private equity, real estate, copper.
  3. Overheating/Peak: Balanced risk - long-term sovereign bonds, investment grade + high yield credit, defensive equities, gold.
  4. Recession: Risk-off - sovereign bonds, gold, AAA investment-grade credit, defensive currencies e.g. US dollar and swiss franc, volatility.

What signs should we watch to flag a move from stage 2 (expansion) to stage 3 (overheating)? The high yield spread has been a good signal in the past to highlight a shift in business cycle risk, as in 2015 and early 2020. A shift from narrow and falling spreads (Stage 2) to narrow but rising spreads (Stage 3) would indicate a shift in risk allocation away from risk-on.


We monitor a number of key indicators closely, including the high yield spread, for signs of a shift from the reflation stage to the overheating/peak stage of the cycle. Thus far, with high yield spreads close to historic lows, we remain in Stage 2 reflation, and thus remain positive on equities, real assets and certain commodities.

But this could of course change quickly in the weeks and months ahead.

Equities and Commodities outlook

Positive equities view maintained, for now…

Deterioration of breadth of stock market advance: a key condition of our positive position on equities as an asset class rests on a continued broad-based advance by the average stock in the major US and European indices, namely the S&P 500 and the Euro STOXX. For the moment, more than 65% of the components of each index sit today above their 200-day moving averages, short-hand for being in an uptrend.

However, despite a strong crop of Q3 2021 earnings results, this breadth measure for both indices sits close to our 65% threshold for reducing equity exposure overall. As per the chart below, both indices have been consistently above this breadth threshold for the last 12 months without interruption.

But, a decisive break by both indices below 65% breadth would potentially be a signal for us to reduce our equity exposure to Neutral.

The trend is still your trend… But for now, note that the major European, US and Japanese indices all sit in a continuing uptrend; well above their own (rising) 200-day moving averages. While this remains the case, we do not want to lose out on potential upside.

Crude oil gets the coronavirus jitters

At last, some relief from ever-rising energy prices: as fears rise over the coronavirus 4th wave in Europe (impacting oil product demand). The market also prices the potential for the US and other countries to release part of their strategic reserves, bringing supply and demand more into balance in the short-term.

Brent crude oil spot prices have fallen below USD80/barrel at the time of writing; down from the October peak of USD86, thus providing some small respite on the inflation front together with falling natural gas prices on both sides of the Atlantic.

Could crude oil prices ease further in the months ahead? There are clear precedents for crude oil prices falling after a sharp run-up. In 2011 and 2018, after crude oil prices more than doubled, they subsequently drifted lower over the following 1-2 years. A sharp inflationary impact then morphed into disinflation.

The US is a key marginal producer: today, the US produces 11.1m barrels/day of crude oil,  1.7m barrels below early 2020 production levels. Were US shale + offshore oil production to recover further, this could shift the global supply/demand balance, cooling prices.


We maintain our positive stance of global equities on the back of the combination of a strong underlying earnings trend, our outlook for above-trend nominal economic growth in 2022 and heavily negative long-term real interest rates.  A modest mid-cycle correction in equity markets is quite possible in the near-term, but would rather provide an attractive entry point in our view.

Positive Q3 Earnings Surprise

A very good Q3 2021 reporting season

The Q3 2021 earnings season for companies proved excellent on both sides of the Atlantic, albeit not as spectacular as in previous quarters.

In the US, more than 80% of companies announced better-than-expected profits, beating forecasts by an nearly 10% on average.  Moreover, two-thirds of companies reported sales above expectations. Meanwhile in Europe, 56% of companies announced better-than-expected profits and generated profits around 8% above expectations.  These results enabled companies to clean up their balance sheets. 

In the US and Europe, the results were most impressive in the Energy sector, but also in Financials, Healthcare and Semiconductors. In these sectors, future earnings continue to be revised upwards. Conversely, this was less the case for Consumer Durables and Industrials (downward revisions). No more upward revisions for Consumer Staples either. Finally, we are seeing regular downgrades of profit forecasts in China at the moment.

Globally, a large number of companies are facing supply woes and cost increases, especially in the Consumer Goods and Industrial sectors.

Positive expectations for Q4 2021 and 2022

In the United States, a profit of $199 was expected for full-year 2021 for S&P 500 companies before the Q3 season. Following the good results, expectations are now close to $203. It is likely, however, that this level will not be exceeded in view of the cost increases (under fairly good control for now) and supply problems. Profit margins remain high and supply bottlenecks are starting to be addressed. For 2022, profit growth expectations range from +7% to +8% (and +10% for 2023). This seems quite prudent as certain previously-expected tax hikes on US corporate profits will not finally be implemented.

The global economy should continue to be supported by high consumer savings rates, pent-up demand, and robust company balance sheets (allowing for new investments, dividends, share buybacks, acquisitions).

European companies also look well-placed: analysts continue to revise up their profit forecasts.  The 2022 consensus for the STOXX Europe 600 Index is now EUR30.7, up 7% vs. 2021. This expected growth is cautious in our view, given the strong macro growth projections for the European economy in 2022 (+4.2%). The 2022 P/E ratio is low in Europe at 15.6x. The US trades at an estimated P/E 2022 ratio of 22.2x.


Despite the cost increases, the Q3 earnings season surprised to the upside (again). Most companies maintained high profit margins, and in some cases, even increased them. Visibility is low for Q4 2021, but pent-up demand, investment, inventory build-up and reduced supply chain bottlenecks should drive earnings over the coming quarters. We remain optimistic for 2022.

Bonds, Credit and FX outlook

The focus is firmly on the Fed

Risk-on environment prevails: the risk-on environment is just as evident in this year’s fixed income returns as in other asset classes. Leveraged loans and high yield credit have performed well as investors have chased income, while government bonds have underperformed cash.

Rising inflation pressures weigh on sovereign bonds: as core and headline inflation rates continue to rise, expectations of central bank rate hikes have advanced. Interest rate futures now imply a first rate hike by the Bank of England in February 2022, and the US Federal Reserve by mid-2022.

A brake on growth? Short-term bond yields have risen to reflect these higher rate expectations, while long-term bond yields have risen remarkably little despite the sharp increase in medium-term inflation expectations. The bond market seems to price in a combination of higher central bank rates, and a subsequent slowdown in longer-term growth.

Watch the yield curve: This yield curve flattening is a signal we watch very carefully, as it can signal a rising risk of recession, and thus a need to adopt a more defensive asset allocation stance.. 

Outlook change for the EURUSD

The recent sharp move from USD1.16 to below USD1.12 (value of one euro) is likely to be followed by a temporary bounce but that should be limited in time and in amplitude. Our new global economic outlook supports this view. The most important change is focused on the path of monetary policy in the US relative to the eurozone. Indeed, we now expect the Fed to stick to its announced tapering plan, and decide a first interest rate hike in July 2022 (Q4 2022 expected previously). In total, we forecast three 25bp rate hikes in 2022, followed by four more in 2023. In contrast, the ECB is expected to maintain a stimulative monetary policy for much longer. We forecast a first ECB rate hike of 10 basis points in June 2023. This scenario change implies a sharp widening of the interest rate and yield differentials between the US and the eurozone. Historically this has been a key driver of exchange rates and suggests a strong dollar for the coming year. Another reason to expected a limited rebound of the euro is the recent worsening of economic momentum in the Eurozone relative to the US due to COVID resurgence in key countries.

We now forecast EUR/USD to fluctuate around USD1.12 per 1 euro over the next 3 and 12 months.


While we currently maintain a negative stance on developed market government bonds, the extreme negative consensus positioning in bonds (as per recent fund manager surveys) heightens the risk of a contrarian move higher in bond prices, lower in yields. In FX, we now forecast the EUR/USD rate to fluctuate around 1.12 both for the coming 3 and 12 months.

Long-term expected returns

Guy Ertz, Chief Investment Adviser Luxembourg

The economic recovery has been stronger-than-expected and the massive stimulus programs should generate growth levels above long-term averages in the coming quarters and years. The recent rise in inflation should be reversed over the course of next year and have no major impact on the average inflation over the forecast period (10 years).

We do not expect central banks to hike rates before mid-2022 in the US and possibly mid-2023 in the Eurozone. The path should however be gradual. In the US, we have revised up our estimate for the long-term expected return on cash and on government as well as corporate and emerging market bonds. Average bond spreads are assumed to be in line with historical averages. The long-term expected return for government bonds has not been revised in the Eurozone as the monetary policy should remain very accommodative. We revised the estimate for European high yield bonds slightly down as spreads are very tight.

The accommodative monetary policy and low bond yields should remain favourable for assets with higher risk levels. We have upgraded somewhat our expected returns for equities as we now expect a higher growth rate for earnings for the coming quarters. The impact on the average growth rate over the next 10 years is however quite moderate.

Alternative assets, for which we calculate the expected returns based on a premium over cash, have now a moderately higher expected return as we upgraded the expected return for USD cash.

More details can be found in the BNP Paribas WM Flash “Long-term Expected Returns”  (click on title to access link), 18 November 2021.

Edmund Shing

Global Chief Investment Officer
BNP Paribas Wealth Management

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