As all eyes start to turn to 2022, the degree of uncertainty is exceptionally high. Because of the new Omicron variant, of course, but also of mounting inflationary pressures (which could force a tightening in US/European central bank policy) and pending elections in Italy, France and the US – not to forget geopolitical tensions (Russia-Ukraine and China-Taiwan notably). Equities continue in our view to be the best (if not the only) investment option but, with so many black swans swimming out there, we would be looking to reinforce portfolio protections on rallies.
What do we know about Omicron? Scientists need a couple more weeks to fully assess its characteristics but, at this point in time, it would seem that it is less potent than the Delta strain of Covid but far more contagious. As such, according to some epidemiologists, it might actually come to be considered “good news”, to the extent that it could rapidly supplant Delta (which is currently placing great strain on health systems) and lead to herd immunity being – at long last – reached.
From an economic standpoint, Omicron’s impact will of course hinge on the extent of restrictions to travel and activity implemented by governments across the globe. But here too, there may be a silver lining, in that a period of reinstated lockdowns – i.e. cooler economic growth – could help alleviate currently worrisome inflationary pressures. Giving them the “transitory” nature that central banks in developed markets have been counting on, somewhat optimistically in our view, to justify keeping monetary policy ultraloose.
Unless a wage-price spiral were to spin into motion before the inflation data even has a chance of cooling down. Indeed, with consumer prices now rising at an above-5% annual pace in both the US and Europe, and inflation worries all over the media, one can reasonably wonder how patient workers will be before they begin to request pay hikes. We look to the public sector as the canary in the coal mine on this front. With the “safest” jobs and also the best organised unions, state employees are in a position to be the first movers – the private sector then having to follow suit.
Predicting what decisions central banks will take next year, in turn a major driver of financial market performance, is thus extremely difficult at this point in time. Shortly after having been appointed for a second term at the helm of the Federal Reserve (!), Jerome Powell changed his wording about inflation being only temporary. Still, however, he insists that US rates need not be hiked. A stance that is clearly crucial for highly levered governments to be able to pursue their ambitious support and infrastructure programs, but one that could become untenable depending on the trajectory of inflation.
And then there are the political unknowns of 2022, be it in Italy in January (with Mario Draghi now vying for Presidency), France in April (where a shift to the – extreme? – right is a possibility), or the US in November (where President Biden risks losing control of Congress). As for the geopolitical landscape, Russian intentions regarding Ukraine, as well as those of China regarding Taiwan, could also make the new year a rocky one.
Where does that leave us as investors? Well, let us first say that we are convinced bonds are not the place to be. Real rates are negative, meaning that fixed income instruments do not protect against a loss of purchasing power due to inflation. Also, should the US and European central banks find themselves forced to hike rates, bonds will drop in value. We thus continue to prefer equity markets, despite valuations that can only be described as rich. As mentioned repeatedly during the past months, we strive to limit equity risk through diversification and a focus on companies that have pricing power or are well positioned to benefit from the emerging wave of energy transition-related investments. Last but not least, we believe that derivative portfolio protections are warranted. At least part of the stock market risk should be covered in our opinion.
We wish our readers our best wishes for the Holiday Season.