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Inflation and central banks will be in focus. This should be the year where central bank policy really starts to change gear – with other central banks starting to follow the Fed’s line on tightening. But there will be plenty of other regime shifts underway too (in terms of inflation, climate, geopolitics and technology, amongst others).
All this change will make for an environment where complacency around any “baseline” scenarios should be avoided. The pandemic has already shown us that full and quick fixes to complex problems are rare. We should view 2022 as a transition year, enabling investors to position portfolios for the challenges ahead.
Economic recovery from the lows of mid-2020 was never going to be completely straightforward. It has required high levels of both monetary and fiscal policy support. The world has changed over the last two years and many economies are still struggling to readjust.
High rates of inflation are an important symptom of this readjustment process. To a large extent, they reflect a mismatch between the recovery of demand and supply. We can see this in disruption to global production and supply chains but also in labour markets.
Fixing such mismatches will not stop the process of change: the world economy is a dynamic place. To paraphrase what the ancient Greek philosopher Heraclitus is supposed to have said: it is impossible to step in the same river twice. The river is different and you as a person are different too. The inflation “river” is always changing with different drivers; your own personal inflation expectations are changing too.
What change means is that effective risk management of portfolios needs to complemented by longer-term considerations of portfolio aims and composition: you need to think in a structural, rather than reactive, way. I think that there are two essential components to this.
- This is an important time to focus on strategic asset allocation. Using market timing around such complex processes of change won't be enough, with an effective strategic asset allocation likely to prove a much more effective and reliable source of long-term returns. This may also be a less stable investment environment than first appears. Financial repression (artificially low or negative real interest rates) is clearly here for some time to come. But even relatively small changes in interest rates can have major direct and indirect effects on asset classes. We should also not assume that a very traditional asset allocation (e.g. the classic 60/40 equity/bond allocation) will work well. More sophisticated approaches will be needed.
- Environmental and ESG issues more broadly (i.e. including social and governance aspects) will get even more important for portfolios. Environmental issues are now firmly fixed centre-stage in global policymaking, and the implications for investors go far beyond higher rates of inflation. Whatever your stance is here, potential risks (e.g. around stranded assets) have to be faced up to. The switch to a carbon-neutral economy will also, of course, create many interesting opportunities. ESG-related and other long-term investment themes are discussed later in this publication.
As I said above, 2022 should be viewed as a transition year as the global economic and investment environment evolves in search of a new reality. Acting now on strategic asset allocation and ESG in portfolios should help capture this process of change.
Wishing you a successful and wealth-creating investment year.
Christian Nolting
Global CIO
