House View, October 2021
We maintain our tactically neutral position on equities, with the notable exception of Japan, where we see scope for a re-start to Abenomics and for Japanese stocks to continue to close their performance gap with their peers in other developed markets.
Though recourse to options trades, we are prepared for an increase in volatility as markets adjust to slowing growth momentum. While they may consolidate in the short term, we remain broadly optimistic on equities longer term.
With bond yields rising again, the negative performance of government bonds is helping justify our underweight stance on these instruments. But we are overweight local-currency Chinese bonds, which offer attractive carry and a stable renminbi and should benefit from policy easing. We have also turned more upbeat on local-currency EM government bonds in general.
While demand is strong, especially in advanced economies, and while the global covid situation is improving, supply-chain bottlenecks are proving persistent, with the surge in natural gas prices adding to inflationary pressures.
Although it may be moving past its peak in Europe and the US, we believe resilient consumer spending will help to prop up growth in both places. We have lowered our 2021 GDP growth forecast for the US to 6.0%, but are maintaining our forecasts of 6.5% for the UK and 5.0% for the euro area. We continue to think that the Fed will wait until 2023 to commence a pretty shallow cycle of rate hikes.
Believing the fallout from leverage issues in real estate will be contained, our forecast for Chinese GDP growth in 2021 stands at 8.7%. Our forecast for Japanese growth is 2.2%.
There is a risk that tensions in natural gas supplies remain for a while, driving up prices, while a general improvement on the covid front has given an additional boost to oil prices. The situation in other commodities has varied, with sharp falls in industrial metal prices but more resistant copper prices.
The support for the US dollar provided by the Federal Reserve could fade, with tapering and a generally less accommodative Fed already discounted by the currency markets. Differentials in growth rates may also work in the dollar's disfavour. As long as global growth proves resilient, we would expect cyclical currencies to outperform defensive ones like the US dollar.
With earnings momentum slowing, we expect H1 22 to show earnings growth well below the level seen in H1 21 as corporate margins face increasing pressure. Alongside a neutral stance on developed-market equities in general we have an underweight stance on US equities as bond yields rise. Valuations remain higher than before the pandemic in defensive sectors and tech.
High inflation expectations and market pricing of rate hikes (with the Fed seen as starting to raise rates in December 2022) contributed to the rise in bond yields in September. Now close to our year-end targets, our analysis and monetary policy forecasts suggest that the increase in yields could peter out in the coming weeks.
With the creditworthiness of Chinese government bonds untouched by local real estate issues and with policy stimulus moving forward, we remain overweight Chinese government bonds. We note little contagion of real estate's problems from Chinese high-yield credits to investment-grade ones in China or Asia more broadly.
However, the situation in China warrants monitoring as the authorities attempt to balance efforts to promote market discipline and stability while at the same time avoiding short-term contagion risks. Earnings revisions for stocks in Asia outside Japan are fading, meaning we remain cautious.
While stable, recent events leave the renminbi looking less attractive than at the start of the year, although their sensitivity to China's prospects could affect the relative performance of other EM Asian currencies.