Q1 has seen the first signs of the re-opening of our global economy thanks to vaccines and heavy government spending. We expect a global economic rebound moving slowly in Q2 and accelerating in the second half of the year. Inflation is likely to increase as it comes from depressed levels (base effect) and as the economy re-opens, but central banks are likely to ignore this. We believe that an environment where growth rebounds and central banks are on hold is supportive for Emerging Markets particularly as the Chinese and eventually Indian economies also surge. Yet, there is another side to this. As the economy improves globally, concerns will also rise again that the end of easy monetary conditions is coming. That in turn means a steeper yield curve in the US and pressure on Growth stocks. In such an environment, listed infrastructure, flexible solutions and covered bonds tend to reduce the risks of a typical portfolio.
Some European optimism
The European economy is expected to grow 4.3% in 2021 according to economic consensus, with a slower delivery of vaccines than in the United States, in particular in Germany. Hopefully, this situation should improve as more vaccines become available. The EU Covid-19 fiscal package also offers much hope for the periphery, in particular the EUR200 billion package for Italy under Mario Draghi. The ECB is on hold for a considerable amount of time even as inflation surges in Q2 and fights against any large spike in sovereign yields.
US economic rebound
The American economy is expected to grow at least 5% in 2021. Nonetheless, with a USD1.9 trillion fiscal package in the United States and a likely 3 trillion one, growth is likely to exceed consensus. The essence of the debate is whether this will be inflationary enough for the Federal Reserve to react to it. That debate should keep oscillating in and out of the markets for the next few months putting some upward pressure on the US Treasury yield curve. Our assumption is that the Fed stays on hold till 2023 and tapers bond purchases in 2022.
China economic rebound
China is going through a soft patch due to a resurgence in Covid-19 cases which should fade away. Fiscal policy remains accommodative while consumption continues to lag but should improve as the labor market tightens. Exports are strong and expected to strengthen on the back of higher global demand. In particular, semi-conductor exports in Asia Pacific are expected to continue trending up. Faced with this and elevated risk in the housing and to some extent financial market, the central bank will likely hike interest rates by only 20 basis points in the second half of the year when growth is expected to trend at 8%. The government is probably going to continue to pursue a program of cautious de-risking of the real estate and financial systems in addition to following the Five Year Plan with its emphasis on technology, green initiatives and consumption. Faced with the risk of a confrontation with the United States, China is likely to intervene less in its currency market.
The rebound in economic activity in China and eventually India can be expressed via Asia Pacific equities. We focus also on global social empowerment, a megatrend supported by multiple drivers (economic, social and technological) while equities are seen as a partial hedge towards inflation. If the economy overheats, global listed infrastructure should still benefit from government spending in Europe and the United States. This is a defensive asset class, trading at historical discounts with high exposure to secular trends like ageing assets, de-carbonization and data growth, which will further drive growth potential. A steeper curve should also benefit European financial debt, while Covered Bonds offer safety, particularly at low duration.
The environment in Q2 should be broadly supportive for risky assets, though fear of bouts of persistent elevated inflation could alter this scenario. We expect to see bouts of volatility from this, as well as periods of lower growth expectations. This continues to suggest holding flexible solutions that can quickly adapt to new circumstances using dynamic asset allocation.