Macro-Economic Update for Q4 2021

This is a macro-economic updates for investment insight, for the month of October 2021. 

With regards the pandemic, the delta variant of Covid-19 is challenging the positive impact of vaccine rollout.  The concern is that the declining efficacy of vaccine suggests some form of social distancing might remain in place in the foreseeable future.  As a result, exposed workers continue to delay their return to the labour market, impacting supply chains. 

Although global economic slack has continued to recede since the 2^nd quarter, 2021, progress has been uneven, and much of Asia, excluding Japan, is lagging.  The pace of recovery is increasingly limited by the global labour shortage and supply chain bottlenecks.  As winter approaches, the energy challenge in Europe and China is another risk to global growth. 

The probability of quantitative easing tapering in November has increased as further progress in reducing unemployment has been achieved.  That Federal Reserve interest rates liftoff is likely to happen in the 1^st quarter, 2023.  The developed market monetary policy stance is shifting to normalisation, creating a divergence compared to Asia, excluding Japan. 

China’s regulatory changes and deleveraging policy are impacting multiple sectors including real estate.  While the objective is to reduce systemic risks and promote long term quality growth, short term activity could be impacted.  Together with the impacts from the ongoing energy shortage, the possibility of some policy easing to counter the downcycle is increasing. 

S&P 500 companies have produced stellar earnings results, beating analysts’ estimates.  Current relative valuation still favours equities over bonds and credits, while liquidity remains ample.  Looking ahead however, risks to equity outperformance are gradually emerging.  These risks include the energy shortage, and quantitative easing tapering, in the near term; as well as Covid-19 becoming endemic, and the labour market mismatch in the longer term.  Meanwhile, although the recent rebound in US Treasury yield has improved the investment value of US credit, the yield pickup from Asian credit is still sufficient to justify the relative overweight. 

In equities we the above-trend growth among major developed economies is expected to continue to at least the first half of 2022, supporting the momentum of upward earnings revisions in developed market equities.  However, risks to equity outperformance are also emerging.  The impact of regulatory changes and deleveraging in China continues to weigh on Asia, excluding Japan, equities performance.  As such, we are maintaining a neutral allocation to the region. 

Regarding investment-grade credit, US investment grade credit default rates remain below historical averages.  The recent rebound in Treasury yield has also improved its investment value.  Asian credit remains attractive with the spread pickup.  However, the potential contagion from China’s Evergrande situation could trigger risk-off sentiment over Asia, excluding Japan, credit.  This means we recommend a reduction to the relative overweight of Asian investment-grade credit to US investment-grade credit. 

On Treasuries, US Treasury yield climbed higher after the September Federal Reserve meeting.  The path to quantitative easing tapering remains on track and the expectation on future demand and supply conditions of Treasuries will continue to adjust, resulting in higher yields.