Volatile markets may provide fertile ground for stockpickers
From a macroeconomic perspective, there are at least three questions to consider as 2022 unfolds. As these questions are answered, the equity markets will likely be volatile, which can be fertile ground for stockpickers:
- What will be the evolution of real interest rates given the potential economic slowdown and the cyclical upward pressure on inflation?
- As China's growth continues to decelerate, what support measures will the government put in place to cushion the slowdown? And how will the trade relationship of China and the US evolve in the context of “digital Darwinism”?
- How will countries work together on a range of big issues? The energy transition is critical: how will we calibrate the long-term transition to green energy and the shorter-term impact of the recent economic rebound on the oil supply and energy markets? In terms of the global pandemic, how will improved access to the Covid-19 vaccine limit the unpredictability of virus waves and lockdowns, and will this lift global economic growth beyond the “base effect”?
As equity investors, we will be particularly attuned in 2022 to the effort to combat climate change. There will be a growing number of initiatives from investors, asset managers, governments and communities, and all of them will need to be factored into investment decisions. This is where the integration of strong ESG data can make a big difference. Above all, it will be important for equity investors to be highly selective. At the same time, they must remain focused on their established investment processes and risk controls.
Amid low yields, look for proactive central banks and “green” bonds
While the global economy is set to remain in expansionary territory in 2022, we recognise that the initial impressive economic growth rates achieved as economies reopened following the Covid lockdowns will not be sustained. Central bank and government action since the onset of the pandemic has significantly reduced some of the worst-case scenarios for the global economy, and dramatically diminished the prospects of a credit crunch. The path of inflation over the next 12 months will have to be watched closely, along with the way central banks react to these pressures.
Given that multiple factors indicate that interest rates will stay lower for even longer, rethinking portfolios to account for this outlook should be an urgent priority for investors. Risk management and diversification strategies must become far more agile. We are looking closely at selectively overweighting bonds from emerging-market countries where central banks have been proactive in addressing inflation risks – as long as valuations look attractive. In addition, global issuance of green, social and sustainability-linked (GSS) bonds recently hit a record high – evidence of fixed-income investors growing increasingly serious about tackling climate risks and social challenges.
Address low rates, high valuations and inflation with multi-asset strategies
Growth and inflation data will likely remain much more volatile than in past cycles, making predictions increasingly hard to make. That is why we will pay particularly close attention to the potential for negative shocks, such as the risk of a new Covid-19 variant. But overall, we continue to hold a cautiously optimistic view for 2022.
Equities and other risk assets should be partially supported by the tail end of the post-Covid global recovery, and by cash-rich investors fighting off the effects of negative real (after-inflation) rates. Traditional fixed income may be somewhat challenged, as inflation risks stay elevated and major central banks reduce their government-bond purchases. As investors seek diversification against inflation risk, they may want to use a combination of commodities, liquid alternatives and inflation-linked bonds. Overall, the current environment of low to negative interest rates, high valuations and higher inflation might prove challenging for traditional asset classes. Multi-asset strategies that offer exposure to a broad set of asset classes – and have the flexibility to take long and short positions – may help investors address a wider range of risks.
2022 may offer a favourable backdrop for private markets
Given the wide amount of uncertainty inherent in the macroeconomic outlook for 2022, institutional investors should consider the diversifying effect of private markets – which in the main have limited correlation to public markets. From private equity to private debt, from renewable infrastructure to development finance, private markets can cover a wide range of investment scenarios. And with the ability of some private-markets strategies to deploy over a multi-year time horizon, investors can aim to further enhance their overall diversification.
Investors may want to pay particular attention to these areas in 2022:
- Growing geopolitical tensions (particularly between the US and China) seem likely to help certain countries (such as Vietnam and India) benefit from a reorganisation of supply chains. Private-credit strategies focused on the Asia-Pacific region may be well-positioned in such an environment.
- The urgency of responding to climate change has triggered an acceleration of concrete opportunities in energy-transition transactions – particularly infrastructure investments accessed through the private markets. This marks a tremendous and swift paradigm shift.
- No matter your view on inflation, it can likely be accommodated through infrastructure investments. For investors with long-term horizons, infrastructure equity provides a robust solution. And for investors seeking to navigate potential interest-rate increases while yields are near historic lows, the high-yielding infrastructure credit space can offer attractive floating rates and even short durations.
Emphasise sustainability while looking “beyond climate”
As the year progresses, we will likely have answers to several critical questions around sustainability and its impact on the economy:
- Will COP-26 prove to be a defining moment for net zero, how will countries finance and fulfil their pledges, and how will their decisions affect economic growth?
- What could be the near and longer-term implications of the climate transition on inflation and the affordability of goods?
- What surprises can we expect from increased scrutiny of the modern economic value chain, and can reporting practices coalesce around clear standards?
The answers to these questions will add to the growing amount of data that investors need to embed into their decisions, and it’s not yet clear whether this will be helpful or a hindrance. Moreover, as sustainability becomes an increasingly essential factor in asset allocations, we may see more volatility and divergence in market performance – which will be yet another input for investors to process. This foots back to what will make 2022 an important year for impact investing. As investors push for positive societal outcomes related to climate and beyond, there will be a deluge of data on how those outcomes are scoped, measured and reported. Making this information actionable will be a challenge, but one that will ultimately facilitate positive change for the planet.