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Unfortunately the health crisis did not fade from view in 2021. The emergence of the delta variant, with a significantly higher degree of transmissibility and severity than the initial Sars-Cov-2 strain, very quickly dashed hopes of an imminent end to the pandemic. The unpredictable nature of this crisis makes forecasting an even more uncertain exercise than usual but we can expect the virus to remain an important risk factor for the coming year.

Read the analysis by Philippe Celis, Head of Private Banking Investments at Banque de Luxembourg, published in the December issue of Agefi.

Sustained economic growth with regional disparities

After a deep and synchronised recession in the first half of 2020 in the wake of the shutdown of many economies, the strength of the recovery in economic activity has surprised many investors. Global economic growth is expected to exceed 5% in 2021 and the OECD also anticipates solid momentum for 2022, projecting GDP growth of 4.5%. However, this rebound masks significant differences between the various geographical regions.

The recovery in economic activity has been particularly strong in developed countries. The United States has already surpassed its pre-crisis level, while Europe is nudging closer to its pre-pandemic level, thanks to a robust recovery in activity in the second and third quarters. High vaccination coverage coupled with extremely expansionary monetary and fiscal policies have played a decisive role.

Emerging market economies, where vaccination rates are generally lower, had a much more difficult year. This is particularly true of China, which, after being the only country to post economic growth in 2020, has been penalised by a fresh outbreak of the epidemic and by the increasing number of regulatory measures taken by the government.


Mounting inflation has been one of the main concerns in recent months. Inflation rates in the US and the eurozone are currently at their highest levels since the early 1990s.

However, the central banks continue to view the sharp price increases as ‘temporary’ because, the current surge in inflation is more related to supply shortages than to excess demand. Ongoing disruptions in supply chains are preventing companies from meeting demand. This is particularly the case in the automotive sector, which has been one of the main sources of rising inflation in the US. Food and energy costs have also fuelled inflationary pressures. However, these pressures should gradually ease as the health situation improves.

Inflation expectations, reflected in the bond markets, continue to point to normalisation in the medium term, which remains the most likely scenario at present. Wage cost developments will nevertheless be a key variable, to be monitored closely in the coming months.

Prospects for return on investments

Against this backdrop of a sustained recovery in activity, and despite the latest concerns over the omicron variant, equity markets have risen strongly this year. This is due in part to strong corporate results, with earnings growth outpacing share price growth.

However, valuation multiples remain high and are based on profit margins well above the historical average. Although this is qualified by the current historical context of extremely low interest rates, it is very likely that future returns on equities will be lower than the returns investors have been able to achieve in the past.

In terms of relative valuation, equities remain the preferred asset class especially as bond markets, underpinned by massive central bank intervention in recent years, are even more overvalued.

Currency depreciation and paradigm shift

The authorities’ repeated interventions since the financial crisis have boosted the financial markets on the one hand and economic momentum on the other, at the cost of depreciating purchasing power. This situation could become even more problematic if the rise in inflation proves to be permanent.

In a normal environment, investors with savings can get an above-inflation return on cash and maintain their purchasing power in the long term.

But a paradigm shift has taken place since the 2008 financial crisis. As a result of the ultra-accommodative monetary policies implemented by the central banks, the return on cash no longer provides protection against the effects of inflation. This situation is particularly acute for investors in Europe, where interest rates went into negative territory. At the same time, the scale of the interventions has driven down yields on quality bond investments to extremely depressed levels.

The current situation has forced investors to make the difficult choice of accepting a higher risk of volatility, i.e. accepting greater fluctuations in the value of their portfolio (upwards and downwards), or accepting a loss of purchasing power.

The notion of risk must be seen in perspective

In behavioural finance, loss aversion describes the situation when an individual places more importance on a loss than on a gain of the same amount or value. This applies whether the loss is realised, or merely latent. It is one of the reasons why the main risk cited by investors is volatility.

Yet this is a risk that tends to dissipate over time. Since the turn of the century, over a one-year period, the global euro-denominated equity market has already experienced declines of more than 40% but also increases of more than 60%. These performances correspond respectively to the periods from the end of November 2007 to the end of November 2008 and the beginning of March 2009 to the beginning of March 2010. Over a 10-year period, the same market has varied between -1.5% and +15% in terms of annualised returns.

Unlike volatility, the risk of loss of purchasing power is not dispelled over time. For example, 100 euros subject to 2% inflation loses more than half its value in 40 years, reducing it to 45.29 euros while inflation of 3% would see its value fall to 30.65 euros.

Implications for investors

Going forward, wise investors should integrate these two risks into the construction of their portfolio. In other words, the choice of risk profile and the resulting asset allocation must be carefully balanced with the risk of loss of purchasing power.

As cash and quality euro-denominated bond investments have become less and less attractive in the current environment, part of the solution will have to come from equities. However, as some are at extremely high valuation levels, it will be necessary to take an active approach to investing and focus on quality companies to limit the risk of permanent capital loss.

It will also be essential to strive to skilfully diversify the portfolio and adapt it regularly to market developments in order to increase the chances of achieving the investment objective over the long term.

In conclusion, in 2022, more than ever, investors will have to master the concept of risk-taking in a calculated manner by combining prudence, rigour and discipline in the management of their assets.

Article by

Philippe Celis, Head of Private Banking Investments, Banque de Luxembourg

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