Laurent Denize, Global CIO Asset Management.

It paid off for investors last year to have kept their nerve and seized opportunities. Those who remained loyal to equities despite recurring uncertainties caused by new Covid 19 variants were rewarded with double-digit increases. In the new year, there is still no real alternative to equities in sight. Rising infection figures no longer automatically lead to a restriction of mobility and economic activities in view of the increasing immunity of the population. As the year begins, inflation and the accompanying turnaround in interest rates are the big talking points. The rising inflation figures are due to a combination of factors: changing consumption patterns due to lockdowns, disruptions in global supply chains and oligopoly structures in various markets. Pointedly, a V-shaped recovery in demand met a U-shaped recovery in supply. Eventually, supply will adjust to demand over time and inflation will fall again. But until that happens, it is up to the central banks to initiate a normalization of monetary policy without jeopardizing the ongoing recovery of the economy. Whether this can be done without friction remains to be seen.

Living with rising interest rates

In any case, the capital markets will have to live with rising interest rates The support to the financial markets should come from the macro-economy. It is true that GDP growth will not be as high as in 2021, which was marked by the rapid recovery from the Corona shock of the previous year. But it should be above potential growth, especially in Europe, which is still catching up due to the prolonged constraints. This should also benefit earnings momentum, which should support equities.

The Fed should be the first central bank to normalize its monetary policy, which could weigh on US equities, at least temporarily. But this is not the only reason why it is time to increase exposure to Europe. European equities are now massively undervalued relative to US stocks. Moreover, industrial stocks, which are overrepresented in European indices, should benefit from rising capital spending. We also see China as attractive in the medium term, although tighter regulation of internet platforms and real estate should still weigh in the short term. The signal for a re-entry could come from government stimulus measures and a more dovish Chinese central bank. The focus should then be on China-traded equities and state- supported sectors such as electric mobility.

Tailwind for cyclicals and value

Rising yields should favor value stocks, cyclical sectors and conversely weigh on tech stocks. Overall, we recommend positioning in sectors that will benefit from private or public investment, the energy transition, and the digital transformation, for example the automotive and construction sectors. Banks also still offer opportunities given the rising interest rates and the transformation of their business models. For investors, it is also high time to prepare for the ecological transition - where themes like clean energy, energy efficiency or sustainable mobility will see double-digit compound annual growth rates for the years to come.

In the Fixed Income market, we expect a steeper yield curve. Rising government bond yields will lead to significant capital losses in long duration portfolios. However, the combination of above- average economic growth and continued accommodative monetary policy in Europe will continue to provide support to the high-yield bond market in 2022.

More volatility and the slow unwinding of central bank support for capital markets suggest that active asset management will be key in 2022. Active managers will have to favor companies that have sufficient pricing power to pass on cost inflation in their prices, or whose debt sustainability is sufficient even for a period of rising interest rates. Passive strategies that track the entire market, on the other hand, will have a harder time.

At a glance:

• Regionally, we prefer Europe in view of attractive valuations and indices composition more tilted toward sectors benefiting from strong GDP growth; in China, we are waiting for signals for a good entry point.
• The focus is on cyclical equities benefiting from the economic recovery, especially small-cap stocks, and on value stocks benefiting from rising interest rates.
• In view of continuing growth, high-yield in the fixed-income sector continues to offer good opportunities for positive returns, and long durations should be avoided.
• The rather high valuations of equities continue to argue in favor of a diversification in alternative asset classes particularly private equity and private debt.