Ten Investment Convictions for 2022

The recovery is still incomplete and the pace of economic expansion will inevitably slow from its exceptional highs. Our outlook for global growth remains constructive. Unless we experience a new wave of vaccine resistant Covid infections, or major geopolitical turmoil, the risk of a pronounced global economic slowdown in 2022 looks limited.

In 2021, inflation became a key concern. Next year, we expect inflation drivers to shift from the one-off ‘base’ adjustments reflecting supply bottlenecks and pent-up consumer demand, to more typical mid-cycle rises in rents and wages. Since these new pressures should prove longer lasting, we expect the US Federal Reserve and European Central Bank to respond by raising interest rates in a series of steps, starting in 2023.

By then, this unusually rapid economic cycle will be reaching a later phase. Monetary policy normalisation and scaled-back fiscal spending will leave less margin for errors, and markets will price risk accordingly.

Geopolitical dynamics may also play a role in market volatility. These may include strains between China and the US, the US mid-term elections, and nuclear relations with Iran. In Europe, tensions over the UK’s relationship with the EU will roll on and France holds presidential elections in April.

Along with more volatility, the process will create opportunities for investors to differentiate between asset classes, sectors and regions. Active management is key to selecting appropriate risk exposures in portfolios. We believe that sustainability will drive investment performance, and continue to prefer companies whose business models contribute to the transition to net-zero.

In this publication, we outline our ten strongest convictions for this unique investment cycle.

1. Start rebuilding cash buffers in portfolios

Current markets are constructive for investment portfolios, but this cycle is evolving fast. High but slowing growth, along with gradual fiscal and monetary tightening, means that volatility should rise in 2022, both in frequency and in the range of potential market declines. With elevated valuations across most asset classes, gradually rebuilding a portfolio’s cash buffer will help investors pursue opportunities when sell-offs eventually occur.

2. Further reduce exposure to high-grade bonds

Developed market government bonds are a good candidate to fund an increase in a portfolio’s cash. Inflation is proving higher than expected and central banks are normalising monetary policy while governments’ fiscal plans mean that large bond issuances are still needed to fund deficits. Yields remain low or negative, and do not compensate for potential losses from increasing rates. Investment grade (IG) bonds in developed markets are only marginally better. While default levels are low and demand for IG bonds remains, valuations look high with spreads below their long-term averages and little room to fall. This offers little incentive for investors.

3. Sound earnings continue to make equities attractive

For the first time, companies have posted double-digit, earnings-per-share surprises over six consecutive quarters. Earnings are strong enough versus valuations to reward equity investors with a premium slightly above their 20-year average. Valuations remain high across all markets but historically are a poor predictor of short-term performance. As the economic cycle advances, the momentum in improving earnings revisions will slow, but for now, the recovery is still incomplete and favours risk assets. Regionally, we like pan-European names, where both earnings and valuations have room to catch up with global equity markets.

4. Keep a bias towards value and cyclical stocks

At this phase of the economic cycle, business trends should support value stocks such as energy, financials and automakers, as well as cyclical names in the industrial and materials sectors. These equity styles, plus small capitalisation stocks remain attractively valued, and we believe that still-strong global growth means that they may outperform.

5. Tilt emerging-hard-currency overweight towards Asia

Emerging market hard currency bonds provide an opportunity to earn carry yield in fixed income. Overall, valuations are less stretched than for other credit segments, with spreads just wider than historical averages and good support from fundamentals in most emerging economies. Chinese real estate pressures have recently been a drag on the segment. While there is still uncertainty on the outcome, we believe that current valuations already largely discount many of the potentially negative scenarios. We tip our allocation towards Asia as we build exposure in the region’s dislocated credit.

6. Factor-in a stronger dollar and a weaker euro

We expect a stronger US dollar and a weaker euro. The dollar should strengthen as US monetary policy becomes less accommodative. We also pencil-in euro weakness against several currencies, given the eurozone’s weakening balance of payment flows and because the European Central Bank is likely to normalise monetary policy more slowly than others. We see the euro-US dollar falling to 1.12 in the first half of next year, and the euro-Swiss franc trading between 1.05 and 1.08.

7. Take opportunities to cut gold exposure

High inflation may prevent a sharp downturn in gold prices during the first quarter of 2022, but once base effects are absorbed, slower inflation will allow real rates to normalise. This would weigh on low-yielding assets, including gold. While gold prices may stay at current levels for a couple of months, into the second quarter of 2022 we believe that prices will trade lower, to around USD 1,600 per ounce. For investors concerned about inflation, we maintain a preference for broad commodity indices and more specifically, industrial metals which are the most likely to benefit from decarbonisation and infrastructure programmes.

8. Favour tactical and active over passive investment management

A key theme for next year is growing divergence in monetary policy. One implication is that macro managers in hedge funds should benefit, given their potential to exploit rising interest rates, higher market volatility and generally broader differentiation across assets’ returns. These funds’ historically low correlation to other, more traditional, asset classes may prove a portfolio diversification bonus in times of market stress. Similarly, sustainability trends will continue to create opportunities for skilled active managers.

9. Volatility to increase, use it to your advantage

As markets normalise, we expect more frequent sell-offs and more subdued returns. That means investors need a wider set of portfolio strategies. With the right approach, volatility can help investors to manage portfolio risk as well as generate income as an alternative to traditional bond coupons. We see an opportunity to earn a premium from selling call options on the S&P 500, capitalising on high US market volatility.

10. Focus on sustainability as driver of returns

With the COP26 climate summit’s commitments and current energy crisis, financial flows continue to support sustainable investments. This trend is now firmly established. We believe that sustainability is a key driver of financial performance in selecting investment opportunities. Conversely, any failure to address sustainability questions will create sources of investment risk. Companies highly exposed to environmental risk and unable to adapt face increasing instability. We favour companies whose business models contribute to the transition to net-zero, either by providing solutions or by implementing serious changes to their activities that help to curb the environmental threat.

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