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Investment strategy 3rd quarter 2021

Getting the economy back on track has required some three billion vaccines – or some three billion doses of optimism – to be administered. The recovery is so strong that analysts are worried more about resurgent inflation than about new COVID-19 variants. For now, central banks are being careful not to normalise monetary policy too quickly, in order to prevent their economies from taking another turn for the worse.

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Doses of optimism

Unless a new, vaccine-resistant variant emerges, the biggest threat to the global economy and the financial markets in the coming months will be a sharp uptick in inflation. While the recent year-on-year jump in consumer prices was to be expected, given the extremely unfavourable comparison basis, we don’t want to see this trend turn into a lasting wage-price spiral.

The economic recovery is gaining traction around the world, thanks to the biggest vaccination campaign in history. The USA, which was able to vaccinate a large portion of its population very early on, is reaping the benefits of having re-opened its domestic economy. The rebound was particularly strong in the second quarter, which saw double-digit GDP growth on an annualised basis. The pace should naturally slow in the second half of the year. But economies in Europe – followed by emerging markets – should then take over, as their vaccine rollout was slower off the mark.

Households in developed countries have built up huge amounts of savings during the pandemic, and that should underpin global growth in the coming months. Consumers will probably spend these savings in the near-to-medium term, given the high pent-up demand for goods, and especially services. Travel and leisure activities should finally see brighter days after being shut down for so long. Unless a new, vaccine-resistant variant emerges, the biggest threat to the global economy and the financial markets in the coming months will be a sharp uptick in inflation. While the recent year-on-year jump in consumer prices was to be expected, given the extremely unfavourable comparison basis, we don’t want to see this trend turn into a lasting wage-price spiral.

Among industrialized nations, only the US seems to have the perfect storm of conditions to trigger such a spiral. Wage developments in the country will need to be closely monitored. If inflation conditions worsen, the Federal Reserve could start normalising monetary policy sooner. But for the moment, the Fed and the world’s other major central banks are taking a very gradual approach to policy normalisation.

Apart from Treasury Inflation-Protected Securities, the bond market currently offers little protection against the rising risk of inflation. Investors therefore still have to turn to the stock markets for potentially positive returns. Although stock markets had been heading sharply upwards since March 2020, they now seem to have entered a more mature phase, which is typically associated with relatively lower gains and greater volatility.

Against this backdrop, we are being highly selective in our choice of investments and our asset allocation. We are currently overweight on equities and have increased our exposure to Japan – a market that should soon catch up with its peers – and decreased our exposure to certain emerging markets (like those in Latin America) that could be hurt by a rise in US-dollar interest rates. We have scaled back the weighting of international real estate in our investment profiles due to unattractive valuations and the impact that the increase in remote working will have on the commercial property market. In terms of currencies, we have increased our exposure to the pound through investments in medium-term bonds. We believe sterling is one of the world’s most undervalued currencies and that it should soon be strengthened by healthier fundamentals in the UK and a permanent resolution to Brexit.

 

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