House View, September 2021
The 'Who pays the bill?' investment theme we outlined at the start of this year remains valid, with differences in the post-pandemic recovery making country (and sector) differentiation especially important. The shape of recovery plans means that we remain committed to our 'Green Marshall Plan' theme, while persistent supply bottlenecks make the 'companies with pricing power' theme even more relevant than before.
As restrictions on payouts to shareholders are lifted and earnings rise, 'dividends are back' remains a favourite theme. And a look at deal volumes means 'The resurgence of M&A' is still on the investment agenda. - We still see opportunities in corporate bonds, as per our 'credit trilogy', while negative real rates mean we are underweight government bonds in the US and Europe. In a low-yield world, we continue to believe in the virtues of private and real assets.
We believe that advanced economies will prove resilient to lingering covid concerns. However, we continue to monitor the potential for pandemic developments in Asia to put further pressure on global supply chains.
Recognising slowing growth momentum amid supply-chain and labour-market issues, we have cut our 2021 GDP growth forecast for the US to 6.1% (from 6.5%). But we are raising our forecast for 2022 to 3.9%. With all eyes on the German federal election this month, we have revised up our GDP forecast for the euro area this year to 5.0% (from 4.3%). We have left our 2022 forecast unchanged at 4.5%.
A sharper-than-expected deterioration in data and stringent response to new covid outbreaks have led us to revise down our GDP growth forecast for China this year to 8.1% (from 9.0%). We have also downgraded our forecast for Japan, to 2.1% from a previous forecast of 2.5%.
Given that the Fed still looks unlikely to raise rates before 2023 and given our belief that the global economy will prove resilient to covid variants, we see limited potential for the US dollar in the months ahead and a chance that cyclical currencies rebound from their recent poor showings. But dollar weakening may be shallower than expected at the start of the year.
After an exceptionally strong Q2 earnings season, H2 should see earnings start to normalise. But we still believe the short-term outlook looks good for European financials, particularly banks. Despite the issues they face, industrials likewise still look attractive, as does Big Tech (including in China).
Despite some slackening, earnings growth in developed markets (DM) should remain healthy in the coming quarters. We expect cash returns to assume greater importance as earnings normalise, particularly in Europe. As we revise up our year-end price targets for equity indices, we expect valuations to fall relative to historical data and sovereign yields. We remain neutral on DM equities overall, while a peak in earnings momentum has led to a slowdown in sector rotation.
More subdued upwards earnings revisions and rising concerns about the growth outlook and regulatory crackdowns in China mean emerging-market (EM) equities have been underperforming their DM peers. While EM earnings trends remain robust, at this stage we continue to favour DM equities.
With Fed tapering already well telegraphed, we have decided to reduce our year-end forecast for the 10-year US Treasury yield to 1.6%. But we think yields could continue to climb gradually in 2022 if inflation proves sticky. We expect TIPS yields to remain negative over the coming months. Our year-end forecast for the 10-year TIPS yield is now -0.8%, compared to our previous forecast of -0.1%.
While spreads on corporate bonds have continued to contract, we still see opportunities. These can be found by investing in financials' subordinated debt and corporate hybrids as well as by taking advantage of credit spread movements to add duration tactically. We also continue to like 'rising stars' (companies on the cusp of being upgraded from high yield to investment grade). But we continue to avoid the lower reaches of the ratings scale.