Real Return: Outlook for 2022
Newton’s Real Return team considers the investment implications of higher inflation and a central bank regime shift.
“The introduction of a more sizeable portion of fiscal policy in the stimulus mix, together with the tolerance for higher inflation by central bankers, constitutes a ‘regime shift’. Indeed, this is a game changer which will continue to have implications for all asset classes and correlations, and will have repercussions in terms of how a robust, balanced portfolio is structured to meet its return objective.
Towards the end of 2021, economic momentum looked well underpinned, as pent-up demand was unleashed and the Covid pandemic transitioned to an endemic phase, with little appetite from politicians to lock down economies again. Companies remain in a restocking cycle, and while this may have been set back by supply-chain bottlenecks, encouragingly we we have started to see signs that pressure on supply chains is easing, which suggests that we may have seen the peak of supply-side inflation. Further out, we see the potential for corporate capital expenditure to rebound, while government investment in infrastructure, particularly in those areas related to climate change, looks robust. Finally, while emerging markets have lagged in terms of rolling out vaccination programmes this year, and thus been more vulnerable to the Covid-19 Delta variant, this situation is improving, resulting in many of these economies having catch-up potential, although, as always, there is a need to be highly selective.
Heading into 2022, we remain constructive about the backdrop. As we move through the year, the risk to this stance is the rate of growth slowing as the Fed tapering programme comes to an end and interest-rate hikes in the US commence. While we believe the process of rate tightening will be a gradual one and policymakers will be data-dependent, maintaining a ‘Goldilocks economy’ that is neither too hot nor too cold will be a challenge. Any policy mistake will have profound repercussions for asset classes, given the rich valuations across the board heralded by the historic low level of interest rates.
Sustainable themes will be high on the agenda as the urgency of issues such as climate change places the spotlight on companies’ ESG credentials. We believe ESG is essentially ‘finance 101’ and such considerations are valuable elements of the overall ‘mosaic’ of information on a company. Investors will increasingly demand for greater attention to be paid to these aspects, as well as their being reflected in a company’s valuation. While some areas such as renewable energy have been eclipsed in the recent past by the stellar performance of equity markets, the balance may shift as equity supremacy ebbs.
Finally, currency may have a role to play for some investors, with the potential to use the US dollar as a risk-reduction tool, although our views on the direction of the currency are not skewed decisively in either direction. In the near term, dollar strength is likely to represent a headwind for assets such as gold and emerging-market debt, diminishing the appeal of these assets. Moreover, in the case of gold, competing flows for other alternative currencies such as bitcoin, along with the potential for rising real rates, make the commodity less attractive.
In summary, we consider that most of the good news is currently in the shop window. We acknowledge that, from a macroeconomic perspective, persistently high inflation can carry the seeds of demand destruction and also run the risk of policy error on the part of central banks. Moreover, China represents a significant source of uncertainty with its new agenda of social prosperity and the likelihood that the quantity and composition of economic growth it generates is set to change from here. This will have repercussions and necessitates vigilance and careful analysis for investors.”
The Newton Real Return Team
GE776021 Exp: 24 May 2022