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It has now been 21 months since the WHO announced a global pandemic, and life still feels far from the pre-COVID normal state. The world has moved quickly in all spheres and the brilliance of biotech development has allowed for a somewhat quicker than expected reopening of economic activity. Nonetheless, the health risks of the pandemic are far from over and structural disruptions in many supply chains have led to stronger inflation dynamics, creating a more uncertain path for global recovery, as monetary policy will have to walk a fine line between managing inflation risks and continuing the support for economic recovery.
It is also important to mention that although the world is highly interconnected – as emphasized by the virus – the vast discrepancy in policy responses across the world has created large economic divergences across regions and even intra-regions. While more than 60% of the population in developed economies are fully vaccinated and receiving booster shots, less than 7% of the population in low-income economies are fully vaccinated. A similar magnitude of differential exists for the extent of fiscal policy response implemented in developed nations compared to developing nations to counter lockdown economic slowdowns. These subtleties make synchronized beta calls across and within asset classes more difficult and instead welcome us to embrace more complex economic analysis that seeks to decompose risk exposures and understand future industry, country, and company specific dynamics in more detail. This is precisely the investment environment where we favor fundamentally active investment strategies over passive index allocations.
For the sake of putting into context the large recovery we have experienced over the past 12 months, let's compare the barometer of multiple health and economic metrics between December 2020 and December 2021. As of December 14th, there have been 8.47 billion doses of COVID vaccines administered around the world. Just to use the United States as an example, the number of doses administered as of Dec. 15th sits at 488 million compared to less than 6 million as of December 31st, 2020. The rolling seven-day average of daily COVID-19 deaths in the U.S. stayed above 2000 from early December 2020 until the end of February 2021, reaching a peak of 3400 around mid-January. That figure decreased drastically over the summer, and only spiked with the Delta variant in late September – but only reached 2000 for a couple of days.[1] The roll-out of boosters in Q3 helped manage the wave, and although the new Omicron variant and the winter environment have led to a new uptick, health experts do not expect the same spike from December 2020.
Let’s shift gears and look at the changes in employment experienced post the meltdown in March 2020. The International Labor Organization (ILO) calculates that 8.8% of total working hours were lost in 2020, equivalent to 255 million full-time jobs – half of that figure from outright employment losses. As of the close of H1 2021, the total working hours lost sat at 127 million full time jobs, not including the number of foregone new jobs. If we look at the U.S. numbers, the U6 unemployment rate[2] closed the end of November 2021 at 7.4% (lower than the 7.7% level in January 2020) compared to 11.6% as of the end of 2020. The change in both health and employment metrics over the past 12 months has been colossal, yet risks are far from over. Expected global growth[3] is 4.9% for 2022, down from an expected 5.9% for 2021 and a 3.1% contraction in 2019. The U.S. expected growth is around 5.6% for 2021 and 4% for 2022. Even if the Senate approves Biden’s Build Back Better Act, fiscal policy is also contracting relative to 2021 values. After jumping over 47% in 2020 and climbing over 4% to $6.818 trillion in 2021, federal spending is projected by the CBO to be around $5.870 trillion.
It is evident that the recovery was strong and quick in late 2020 and 2021, and therefore growth globally and in developed nations will most likely slow to more normal levels in 2022.
The macro situation in the U.S. was very positive in 2021. As commonly known, consumer spending is the driver of the U.S. economy, commanding around 70% of the total GDP of the country. Consequently, personal savings rate and retail sales are always excellent metrics to determine the health of the economy. The Personal Savings Rate in the U.S. hovered around 7.5% in the decade between 2010-2020. This figure jumped to 33% as of April 2020 and closed 2020 around 14%. 2021 saw a continuous decline from 14% to the latest available reading of 7.3% as of November.[4] This decline in savings was matched by rapid growth in retail sales. Monthly sales in February 2020 were around $460b and had consistently posted a ~4% YoY growth. The latest figure for November 2021 was $566b, significantly ahead of pre-COVID growth pace. The latest communication from the FED FOMC shows a committee happy with the pace of job gains and projects U3 unemployment will settle around 3.5% by year end of 2022. While taken in isolation, the above metrics would show a well-recovered economy with positive yet slowing momentum – inflationary pressures have started to create significant shift in Central Bank reaction functions. This comes as the highest U.S. macro risk in the next 12 months, as we could witness even more hawkish moves from the FOMC, which could directly affect the appetite of risk assets and cause strong moves in the yield curve.
The U.S. equity markets posted another strong year. Limiting our discussion to the S&P 500 index, earnings for 2021 were up around 45% relative to 2020. Energy, real estate, financials, and IT were the strongest sectors, in that respective order. Sales growth for the entire index was around 16% for 2021 and the consensus expectations are around 10% for 2022. It is inevitable then to expect a much tamer return environment in 2022 from U.S. main indices. Earnings growth will very likely be lower but still positive and is likely to expect a modest increase in dividends and a contraction in valuation multiples.
The story of European assets is not too dissimilar to that of the U.S., albeit has divergences in growth repricing. The STOXX index posted a 26% EUR return, only shy to the S&P by 3%. However, the euro weakness increased the performance gap to 12%. Although Europe was more sanguine than the US with COVID economic restrictions and has proven to be more risk averse to COVID case spikes, as witnessed by restriction increases following the Omicron variant surge, it has several factors to its advantage. Fiscal Policy is expected to expand in 2022[5], valuations are cheaper, and the ECB has mentioned it is very unlikely there will be IR increases in 2022. Europe’s greater weight to financials and cyclicals means that on an index basis, excluding currency dynamics, it is possible to see potential outperformance if economic activity continues normalizing.
Emerging and low-income economies have been the main victim of the pandemic. Lack of access to vaccines and deficient health care facilities have led to significantly slower economic reopening programs. Moreover, businesses could not count on the magnitude of fiscal support provisions offered in high-income countries. A strong Chinese recovery since Q3 of 2020 helped anchor commodity export economies, yet the early 2021 economic shift from the Communist Party of China (CPC) to continue their structural deleveraging campaign quickly dissipated the Chinese tailwind. This resulted in a poor return environment for most EM countries, partly from lackluster growth inflationary pressures that forced many countries to increase IRs. The outlook for 2022 is still difficult for the EM set as FEB tightening policies and reactive Chinese policy do not provide strong catalysts. China has changed the direction of their government economic policy, yet the change has been very modest. The central bank cut bank required reserve rates and reduced the prime rate for the first time in 20 months. This policy shift is widely welcomed by the market, yet it still proves to be very marginal in compensating geopolitical risks and to have significant spillovers to EM export nations.
We welcome 2022 with conflictive short-term expectations for risk assets as slower global growth, more restrictive monetary policy, and geopolitical events will impact market dynamics. We expect volatility to pick up as it is very likely risk assets will be more correlated to macro undercurrents. Higher than expected inflation readings and unexpected hawkish moves from CBs will likely generate strong rotations across asset classes and intra asset classes. Consequently, the Investment Committee made the preemptive decision to bring equity allocation back to neutral in October 2021 while leaving geographical allocations unchanged. If portfolios follow normal mandates, the geographical allocation is still similar to the ACWI World Index with a slightly higher allocation to Europe taken from a slight underweight in EM. We continue to favor active strategies that concentrate on quality companies with structural tailwinds, strong balance sheet dynamics, leader positions within their industries, and less cyclical correlations. The money generated from the move back to neutral in Equities has been primarily kept in cash. The main rational for this higher allocation to cash is the following: the risk of higher inflation and therefore a more hawkish FED can create an environment with higher IRs for short and mid-term haven government bonds in the foreseeable future. If this risk materialized, we could very likely see a trading scenario where both equities and investment grade secure fixed income securities decrease in value.
Our fixed Income allocation continues to be very conservative in nature. Our exposure to ex-IG public fixed income has decreased and we are avoiding playing the difficult game of positioning based on yield curve and interest rate expectations. Although we are likely to see higher interest rates in the U.S. from an acceleration of hawkish policy, the path of long-term rates is less clear as economic uncertainty creates wide discrepancy on growth expectations in the long term. Consequently, whenever possible we continue to move away from public credit into core asset carry plays and other private credit strategies that provide higher carry.

JP Villamarin, CFA, CAIA
Senior Investment Analyst at Intercontinental Wealth Advisors

*Markets are constantly changing. Market Update information is a snapshot in time intended for information purposes only. Intercontinental Wealth Advisors, LLC offers various strategies, and different strategies may have different market outlooks.

[1] As published by CDC
[2] U6 is a measure that includes more commonly reported U3 plus discouraged and underemployed workers
[3] Based on IMF October report.
[4] FRED economic data
[5] Recovery Fund was agreed on in 2020 and started to flow in 2021, yet the majority of money spent will be in 2022 and 2023

Chart 1. Reference Indices 1Y Performance as of Jan. 4th, 2022

*This information is prepared internally and sourced from the Bloomberg terminal.