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Market Commentary

4th quarter 2021

Reading time 10 minutes
  • Financial markets unimpressed by rising inflation. Central banks' message remains dovish: interest rates will rise but will not derail economic growth.
  • Interest rate curves flattened during the quarter: short and medium maturities rose the most, anticipating a tightening of monetary policy; long maturities continued their long-term structural decline, supporting valuation of expensive stocks.
  • Economic growth remains robust and is expected to remain so in the coming years, thanks also to supportive fiscal policy. Covid is still a limiting factor, but vaccination clearly helps and people are getting used to living with the virus.
  • The CHF yield curve is still in negative territory, but substantially lower inflation and a low level of government debt are attracting investors, causing CHF to appreciate substantially.
  • The performance divergence between developed and emerging markets widens even more in the fourth quarter: in 2021 the Chinese market falls by 21%, while the US market gains 30%.

Dovish central banks, stoic financial markets

Years ago, inflation of 6.8%, as recently observed in the US, would have sent the financial markets into a tailspin. Not this time, not with the Fed reassuring the market that they are in control and that tightening monetary policy will not endanger ongoing economic growth. Their message is: interest rates will rise, but by historical comparison, they will stabilize at a low level and remain supportive for financial markets. At the same time, the expectation of robust economic growth remains intact thanks to the unprecedented amount of government spending and high household savings. Covid is still a major constraint on social life and the economy, but at least in developed markets the vaccination is helping and people are getting used to living with the virus. Equity markets performed strongly during the quarter, with a few notable exceptions such as China. Bonds, on the other hand, performed negatively as a result of the general rise in interest rates.

A classical: inflation differential drives CHF appreciation

The Fed, by resolving uncertainty about how it will deal with inflation, has given the market a boost. But the large inflation differential between countries has had a strong impact on currency appreciation. This is particularly the case for CHF: in Switzerland, inflation is at an acceptable level of 1.5%, 3.5% and 5% lower than in the EU and US respectively. At the same time the interest rate differential is almost zero (against EUR) or very low (against USD). This has revived a classical dynamic for the CHF: stability, low inflation and a low level of government debt, resulted in a strong appreciation of the CHF. All this put pressure on the SNB, which is still restricted in its freedom of action by the ECB's monetary policy. In other words, the currently still negative interest rate in Switzerland will remain for a while. It is encouraging that the strong CHF has not yet dampened export activity. But perhaps it is too early for an assessment or the Covid induced bottleneck in the supply chain is making foreign buyers accept higher prices.

A strong quarter/year for equities worldwide, with some notable exception

Strong performances characterized most of the world's equity indices. The Swiss equity market did not appear to be adversely affected by the strength of the CHF: the SPI index reached a new all-time high at the end of December, ending the year with an exceptional performance of 23.38%. The US S&P 500 rised 11% in the fourth quarter and almost 30% over the year. Different story for emerging markets, whose performance in Q4 was negative on average. China in particular lost significantly: -6% and -21% resulted for Q4 and 2021, respectively. A different wind is blowing in the Chinese market than (at the other extreme) in the US. The structural weakness of the economy, which relies heavily on debt (including shadow banks), the impact of Covid and the government's heavy hand on certain sectors and companies have reduced risk appetite. However, China's reality check in 2021 comes after an increase of almost 100% in the previous four years. The significantly better performance of our newly launched "OLZ Equity China Optimized ESG" clearly shows how important it is to keep an eye on risk when investing in a volatile market like China.

It is not glamorous to stay sober while the party keeps going on

Risk indicators fluctuated widely during the quarter, rising until the end of November and falling substantially in December, below their historical average level. Investor sentiment remains very optimistic, fueled by dovish central banks and the government's generous spending program There is no room for latent risks in this market assessment (out-of-control inflation, geopolitical tensions, reduced government spending due to rising public debt, etc.). Market valuations appear rather stretched in historical comparison. This is particularly the case for Growth (technology stocks) and Quality stocks, whose valuation continues to be supported by the ongoing compression of very long-term interest rates. Our risk-based approach tends not to select these highly expensive and volatile names and therefore does not participate fully in the party, underperforming the market. Does it make sense to maintain a risk-aware posture in such a market? To answer this legitimate question, we need to put the situation in historical context and at the same time take a look into the future. Situations characterized by exceptional circumstances, such as the current one, do not last forever. Every financial market crises of the last 40 years is a witness to this very simple truth. Same as in a party, we remain on the sober position, among other things because we do not know when the punch bowl will be taken away and the party will end.

OLZ CIO Carmine Orlacchio

Carmine Orlacchio

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