Exposure rates of the Dorval Asset Management Range – 21st January 2022

The forthcoming emergence from the Omicron wave is set to drive a fresh uptick in world economic activity, benefiting certain services in particular. This recovery will fuel investor questions on the Fed’s attitude to signs of overheating.

Most investors expect the Fed to announce an initial 25bp rate hike on March 16, followed by three others during the year, on a par with the pace of rises witnessed in 2017 and 2018. If the Fed decided to up the tempo and hike rates by 25bp at each of its meetings from March onwards, the fed funds rate would end up in the 1.75-2.00% region at the end of the year (cf. chart 1), which is still short of projected inflation. The Fed will probably also announce moves to prune its balance sheet.

 

The Fed is coming under hefty political pressure to take up the baton against inflation, but forceful action would mean triggering a clear economic slowdown that no-one wants to see. Additionally, medium- and long-term inflation projections remain anchored at perfectly normal levels (cf. chart 2), making for an argument against a dramatic tightening in monetary policy. Lastly, faced with the complex situation resulting from the Covid crisis, the Fed is very likely to simply state that it will rely more heavily on economic data than before – with the end of forward guidance – adjusting its policy on the basis of changes in a range of inflationary pressure indicators i.e. bottlenecks, commodities, wages, etc.

 

On the financial markets, anticipations of the Fed’s moves – with the FOMC on January 26 – along with fears of a deterioration in the situation in Ukraine have powered volatility. However, the most noteworthy change over recent weeks remains the drop in valuations on the priciest stocks that are most favored by many individual investors. This process had already kicked off at the start of last year, before going on hold over the summer. It resumed in full swing in November, with a sharp plunge for green techs, biotechs, small US tech stocks, and lastly the bitcoin (cf. chart 3).

 

 

This consolidation is very good news in itself, and has slightly spread to large growth stocks, although these shares have qualitative features that set them apart from fallen angels: with average P/E of 28x, GAFAM for example do not necessarily fit in the overvalued asset category. In our portfolios, we continue to focus on a highly diversified approach, which tends to limit the aggregate valuation. By way of example in our international funds, the aggregate P/E for stocks in our portfolio comes to 15.5x vs. 18.2x for the MSCI World.

 

 

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