2021 featured a shift in US monetary policy. All year, the world’s financial markets kept a close watch on Federal Reserve boss Jerome Powell, whose commentary gradually moved in favour of the end of a highly accommodating stance, with asset purchases amounting to $120 billion per month right up to the autumn. But at that point the Fed started to voice concern that at more than 5% year-on-year for some months, inflation could be both higher and more persistent than it first thought. In November, consumer prices were up 6.8% on the year before, while producer prices climbed no less than 13.6% over the same period! Tapering started in Q4 2021 with an initial reduction of around billion per month in asset purchases. That reduction is set to be doubled from this month onwards, which would halt the expansion in the Fed’s balance sheet by the end of Q1 and pave the way to a rise in interest rates… if all goes well.
Eurozone inflation was below its 2% target until the summer of last year, which greatly helped Christine Lagarde’s policy position. But consumer prices started to accelerate significantly from September onwards, generating an inflation rate of 4.8% in November. This may have been the highest level recorded ever since the creation of the European Monetary Union, and producer prices had jumped 21.9% the month before. This situation has left the ECB in a more difficult situation, especially as the Fed had announced a change to its own policy. Even so, Ms Lagarde has remained pretty much unmoved, as retail sales are still sluggish (up 0.9% in the year to October).
In China, problems among real estate developers continue to unnerve economy-watchers. In 2021, investors heavily sanctioned the main listed Chinese groups on the grounds of their excessive debt: the share prices of Evergrande, Kaisa and Shimao slumped by 89.3%, 75.3% and 76.7%, respectively, over the course of the year. These corrections were far greater than those suffered by their benchmark indices: MSCI China dropped 23.5% and the Hang Seng 11.7%. This risk factor is additional to a worsening imbalance in the economy’s fundamentals, where faltering domestic demand contrasts with extremely buoyant international trade.
Fortunately for China, its exports surged 30% last year, which helped offset some of the sluggishness of domestic demand. But this also leaves the country more dependent on good relations with trade partners at a time of strained international politics. It means that Xi Jinping will have the difficult task of perhaps moderating his public utterances on such matters as world leadership and Taiwan if he is to keep China’s economic model on track. If he does opt for sweeter trade relations, it would amount to a fundamental contradiction with the government’s ‘Made in China 2025’ self-sufficiency objective, which sits within its ‘common prosperity’ concept. All in all, Chinese policy begs a number of questions for 2022, and the country’s role as the world economy’s engine of growth for almost 20 years is not nearly as obvious as it was.
At a microeconomic level, 2021 will go down as a great year. Ahead of the Q4 results season, S&P 500 earnings growth for the year is estimated at 45.1%, which would be the highest figure ever recorded since FactSet started publishing this data back in 2008 (the previous record was 39.6% in 2010, just after the subprime crisis). Similarly, S&P firms’ aggregate revenues climbed an estimated 15.8%, compared with the previous high of 10.6% growth in 2011.
Now that Covid-related base effects have disappeared, we are likely to see more normal earnings growth rates this year, with less systematic good surprises. Our valuation model indicates that Wall Street is more or less fair value but that European equities are underpriced to a degree that depends on changes in interest rates (in the event of a slow recovery, rates would inevitably sink towards zero). The market’s 7-15% appreciation potential is valid for all scenarios.
