Commentary December 30, 2021
By all respects, 2021 was an extraordinary year. Major western stock exchange indices skyrocketed without precedent, key cryptocurrencies – an investable asset class still strongly disputed by experts – exhibited spectacularly high volatility and resource prices, before all those for natural gas, multiplicated severalfold. Not surprisingly, monthly inflation rates marked values not seen for decades in the US, the UK and also in Europe.
All this came about amidst widespread new infections with the Covid-19 virus resulting in massive restrictions of public live and a related slowdown in economic activity. This had left little room for optimism at the beginning of the year, at least in the western world. Only hard-boiled optimists would have expected that the economy turned to the better that soon. Yet massive public rescue measures, combining ultra-loose monetary policy with massive fiscal stimulus measures, resulted in a successful stabilization of economic activity in most of the countries affected. Notably, unprecedented large-scale public vaccination campaigns helped reduce the immediate health threat from the virus substantially and more rapidly than any on could have expected before. Even more important, consumer and business sentiment managed a subsequent turn-around that seems to persist not only in the short term. A massive build-up in household savings and a significant backlog in client order processing is therefore highly likely to keep economic momentum alive deep into the first half of 2022.
The million-dollar question is now for how long these fortunate circumstances may persist and what could disrupt positive developments provided that the pandemic can be overcome? With good faith most of the standard economic activity measures hint at a further, but somewhat slower expansion in economic activity in the first two quarters of 2022. This should suffice to support stock indices at their current levels and permit a gradual further rise in the first half of next year. However, disparities and hence volatility can be expected to rise concurrently.
First of all, price pressure could be much more persistent in the months ahead and become more broad-based. Especially, once inflation-expectations integrate elevated inflation rates permanently. Apart from unusually high energy prices and significantly higher wholesale and retail prices for some consumer goods owing to tight capacities, almost cleared labour markets and significant cost from global supply chain relocation are strong arguments in favor of sustained price rises. Second and third round effects appear to be just a matter of time and will let underlying price pressure become much more broader based.
But while stock markets might have a good chance to withstand these headwinds for several months, bond markets seem to have finally reached the turn of the tide. This will mainly be caused by the foreseeable change in central bank policy: the US FED, BoE, ECB and even the ultra-dovish BoJ can be expected to phase out gradually or completely their respective quantitative easing programs and to start hiking key interest rates sooner or later. Apart from recurrent tactical portfolio shifts into safe-haven government bonds, bond prices can therefore be expected to experience severe downward pressure in 2022. To put it bluntly, the previous double party from two typically little correlated asset classes could now finally be over and more caution with respect to interest rate sensitive assets seems warranted.
From a bird’s eye view the numerously cited selectivity can be expected to move even more into the forefront. Multi-asset approaches can be assumed to buffer specific asset class swings best given the current environment, particularly from a perspective focusing on real returns. Considering late business cycle mechanics should reinforce any efforts to bolster performance. Style rotation from growth into value will finally hold true for stock investors and short-term inflation-linked fixed interest instruments will help bond investors master rate hikes better. The latter might also start to consider floating-rate securities or even reduce asset class exposure significantly in the near future before things turn better. Resources should have a good chance resuming their mostly positive trend deep into 2022. However, when looking for example at precious metals‘ disappointing underperformance in USD, this asset class might require a carefully balanced approach too. Thinking of currencies, those betting too hard on an even stronger US Dollar should not underestimate the risk from an abrupt change in ECB key rate policy for the EUR/USD exchange rate.
Beyond all that, there are many good reasons to believe that effects from climate change will ripple through companies‘ balance sheets much sooner and more powerful than what many financial market analysts and investors alike might have expected just a few years ago. In its most extreme – negative – realization, so called „stranded assets“ might become a reality for some business sectors in the immediate future. But not only this, also social and governance issues should be of concern to all of us, as the current pandemic has demonstrated effectively at last. Apart from considering multi-asset pillars, building sustainability permanently into investment portfolios might be a wise thing to do for the near future too.
Manuel Schuster, CEO