As multi-asset managers, clients understandably look to us around this time of year for reviews of the previous 12 months as well as projections about the next 12 and beyond. Our challenge is to offer something more than a list of the year’s greatest hits, economically speaking, and a few heavily caveated statements about what the coming months might bring.
If any profession has taken a hit over the last decade or so, it has been futurologists, with recent events underlining Danish physicist Nils Bohr’s statement (also attributed to perennial quote machines Yogi Berra and Mark Twain) that ‘prediction is very difficult, especially if it's about the future’. While these professional seers are typically investigating more visionary concepts than interest rates or GDP, any forecasting has to be taken with a grain of salt, and this is even more the case when it comes to influencing long-term investment decisions.
As we near 2022, it is worth casting our minds back a decade to 2012, to find the UK preparing to host the London Olympics. Without coming over too misty-eyed, or ignoring the austerity policies starting to bite at that point, this event did spark a certain sense of national pride embodied by Danny Boyle’s Isles of Wonder opening ceremony, unfurling a whirlwind of the nation’s historical, cultural and social memories. Few futurologists at that stage would have predicted that, just four years later, the UK would subject itself to the faultline-exposing Brexit vote, leaving the country as politically and philosophically divided as it has been in decades.
Similarly, as Barack Obama was moving towards winning his second term in the White House, most commentators would have scoffed at the suggestion that, four years later, he would be succeeded by perhaps the most divisive and controversial president in history in the shape of Donald Trump. Post-Donald, the oldest man to assume the office, Joe Biden, finds himself grappling with governing a country riven by dispute, along generational, cultural and racial lines. Finally, as we know all too well, only the most pessimistic Cassandras out there – including, to be fair, Bill Gates – were discussing the havoc a global pandemic might cause before Covid-19 wrapped its virological arms around the world.
With so much uncertainty around any macro forecasting – over the coming years, on top of recovery from Covid and long-term Brexit impact, we also have issues like the growing role of China to consider – how can we position multi-asset portfolios for the next decade and beyond?
Our portfolios are Target Risk so will always have meeting client suitability at the core, whatever is happening in the world, but beyond that, we continue to stress the importance of diversification and preparing for events rather than having to react to them. To give an example, we made a fairly low-key shift back in early 2020 into index-linked bonds as part of our fixed income allocation. While not predicting persistently higher inflation at that stage, we felt that, given the fact central banks were prepared to accept higher prices as a corollary of recovery from Covid-19, some index-linked exposure was a sensible holding. Fast forward to 2021 and inflation has clearly been a major source of concern over the latter part of the year, with many central banks suggesting we could see elevated levels into 2022 – although most continue to insist this still counts as transitory.
Our linkers exposure has been positive in a challenging period for fixed income and by preparing for potentially higher inflation, we were able to buy these assets fairly cheaply when expectations were low rather than reacting to elevated CPI (Consumer Price Index) numbers by piling into an increasingly expensive asset. This kind of knee-jerk asset allocation rarely yields positive results over the long term and rather than attempting to market time, our approach is to remain flexible with a willingness to tilt when the fundamentals change.
As markets have broadly moved upwards since the rapid descent into bear territory in April 2020, many commentators have asked whether we could be on the cusp of another ‘Roaring Twenties’ to mirror the decade after the end of the First World War and the Spanish flu outbreak. As always with this kind of narrative, there are as many differences as similarities, with the world obviously not recovering after four years of total war. But a heady mix of pandemic, surging stock markets, technological revolution (artificial intelligence rather than early radio and television), and growing political polarisation and international rivalry does present an intriguing parallel.
In our billionaires and their personal space race, we also have real-life business leaders behaving just as outrageously as the fictional Jay Gatsby and his coterie of flappers and gangsters. Many of the industrial titans of the 1920s and 1930s made unimaginable wealth by adopting new products and industrial methods – Ford, Hoover, Colgate, du Pont and so on – and there are obvious analogies with figures like Jeff Bezos and Elon Musk.
A major difference this time, of course, is the shadow of the climate crisis, and we would also make the point that however roaring they might have been, the 1920s also saw huge inequality, hyperinflation and ended in global financial catastrophe. For anyone concerned any euphoria could quickly lead to such a crisis again, however, policymakers have surely learnt from history and their sophistication and access to data is far greater than a century ago. In the last 15 years, the global central bank coalition has faced two potentially disastrous situations and navigated both successfully – at least in that markets and economies continue to function.
As we look to next year and beyond, our view is that while interest rate hikes and tapering of asset purchases might feel concerning in the short term, they are ultimately a positive signal the global economy is starting to reach escape velocity from the pandemic – although the Omicron variant obviously brings a fresh sense of uncertainty. Putting that aside for now, we have come faster to the current mid-cycle point than expected, in 18 months rather than the more typical four or five years, but no one should be surprised to see such an accelerated cycle given the unprecedented levels of monetary and fiscal stimulus used to keep the world functioning amid the pandemic.
Concerns around higher UK interest rates also serve as a reminder that, while this might dominate commentator chatter, we are running diversified portfolios on which the impact of exactly when the Bank of England chooses to hike or not should be limited. Central banks are moving towards tightening – and there are understandable worries about how this might affect economic recovery – but they also continue to act in a very market-friendly way, ensuring changes are well telegraphed ahead of time. Four potential UK rate rises are now priced in by the end of 2022, for example, which is probably too many, but higher borrowing costs are clearly already in the price and so cannot be considered a surprise when they ultimately materialise.
While inflation might remain elevated for part of next year – again, headlines talking about a recent 30-year high in the US are dominating chatter – we remain confident levels should drop away in the medium term as the rolling Covid base effects, with gas prices causing a spike one month and used cars the next, gradually work their way through the system. Meanwhile, conditions are in place for a sustained boom in real growth with excess savings boosting consumption and an accompanying tailwind from falling unemployment.
Across our Multi-Asset funds and portfolios, we remain positive on risk assets, albeit recognising we are moving into that mid-cycle phase and the period of everything rising as markets recover from the pandemic is over. We continue to be bullish on the reflation trade that drove performance over the first part of 2021, which looks to be gathering pace again after a summer lull.
Returning to the goal of preparing rather than reacting, this view plays into three of our long-term views: global ex-US equities are more attractive than the ever-expensive US, small caps should outperform large, and value should outstrip growth – all trends running contrary to what happened for most of the 2010s. If we do see another leg of a long-term value retrenchment, we are well positioned to benefit via holdings such as the Schroder Income and Man GLG Japan CoreAlpha funds.
Within equities, we see better value in Europe, where stocks are trading at attractive valuations versus the US due to strong earnings revisions, and the region is also poised to benefit from a value/cyclical-driven market. Emerging markets remain a watchpoint as the regulatory shift in China has caused a re-rating in the region’s stocks, especially in the technology sector. This has made emerging market companies more attractive on valuation but they bring added near-term volatility, and investing in China particularly will have to come with an understanding that the government is likely to treat certain sectors more favourably than others.
Overall, we expect equities to remain the main driver of returns and therefore continue to be overweight, while we have removed some duration from our fixed income allocation while central banks prevaricate over the timing and extent of rate rises and tapering. There remains a split between bulls and bears with respect to economic outlook so we prefer to take a balanced, flexible approach where we can focus on long-term themes and build diversified portfolios able to perform throughout the cycle.
