At the start of the year, the prospect of higher interest rates weighed down on those areas of the market that are most sensitive, which includes technology stocks. Yet we believe this sector can continue to deliver decent profits growth and as a result we’re maintaining our overweight in US equities. The share prices of tech companies have already adjusted to reflect the outlook for tighter monetary policy in the US, and it would take a surprise event to hold them back any further from here.

Looking ahead, we think the investment environment remains constructive for returns from risk assets, although they are unlikely to be as strong as they were in 2021. Asian high yield bonds have also struggled so far this year as investors fear a further escalation of the Chinese property crisis. Yet valuations continue to look attractive and the Chinese government has started to ease its stance towards the sector. We’re maintaining our overweight.

Different directions
Europe is some way behind the UK and US, and the ECB is unlikely to stop buying assets or increase interest rates this year. Meanwhile, China is already decoupling from the rest of the world. Its economy is settling into a slower pace of growth, and its central bank is likely to continue cutting interest rates and keep monetary policy more relaxed. Along with a heavy debt burden in its real estate sector, the country’s zero-Covid policy remains a risk to economic activity.

Although the Omicron variant is spreading rapidly, the risks are greatly reduced. Symptoms are milder and the number of people requiring hospital treatment is much lower, largely due to higher vaccination rates. Despite some regional differences, restrictions on mobility have been less stringent than prior virus waves, at least so far. Geopolitical risks include tensions between the US and both China and Russia, as well as uncertainty surrounding the US mid-term elections but they also remain contained for now.

The world economy is likely to continue to reset over the course of 2022. The pace of growth has probably already peaked in this cycle but should remain solid. Households and business still have plenty of pent-up savings to fuel the recovery, though less than previously. Inflation has remained stubbornly high and yet is also likely to peak over the next few months. Supply chain bottlenecks and disruptions are easing and there are signs that energy inflation should settle back down.

Central banks are under pressure to tighten monetary policy in order to bring down inflation closer to their 2% targets. Yet they also need to make sure they don’t apply the brakes too soon or too hard. The Bank of England has already increased interest rates and all eyes are now on the US Federal Reserve, which has announced it will soon begin to shrink its balance sheet. Three or four interest rates hikes are also likely before the end of 2022.

At the start of the year, government bonds sold off sharply (meaning yields rose), led by the US as the Federal Reserve, at the December meeting, debated shrinking its balance sheet soon after the first rate hike, which markets now believe will happen in March rather than April. With inflation still high and the labour market tightening, the Fed may be tempted to move sooner than expected, although Omicron may yet interfere. However, to put things in context, yields remains low and have only just returned to pre-Covid levels.

Stock markets have been volatile since the start of the year. Inflation wasn’t supposed to still be so high and investors have been unsettled by the prospect of central banks raising interest rates sooner than planned in order to slow the pace of price rises. Markets have also been worrying about the rapid spread of the Omicron variant and whether there will be renewed restrictions on mobility, which could put the breaks on economic activity.

As long-term investors, we’ve already adjusted portfolios to be resilient to rising interest rates and high inflation. For example, we are positioned for rising interest rates, own gold as a strategic hedge and our exposure to equities favours companies that can continue to be profitable by passing on any increased prices to their customers. The pandemic continues to cast its shadow, but we’re confident many of the problems, such as a supply chain disruptions, will continue to fade over the rest of the year as the world resets.

The economic cycle should begin to normalise to solid but slower growth as households and businesses continue to spend the savings they accumulated during the pandemic lockdowns

A resetting world

COUNTERPOINT
FEBRUARY 2022