Welcome to the inaugural edition of the CIO Lens, available here and at the bottom of this page.
Each quarter we will bring you the views and opinions of our investment experts here at Schroders to help you navigate the challenging (and changing) investment times that we find ourselves in.
At the time of writing, the Omicron variant of Covid-19 is leading many countries to reimpose new restrictions on activity to curb its spread.
This is a timely reminder that the current crisis is far from over, despite brief respites of normality when infection rates start to fall, and we are still living through a profound period of business and social change.
And these changes are not all related to Covid-19, although the pandemic is undoubtedly accelerating this process.
In the past 25 years my focus has always been on the interest rate cycle but arguably, going forward, the pricing and regulation of carbon as well as the broader shift from fossil fuels to sustainable sources of energy will be just as fundamental to market performance.
We are in the midst of an energy transition akin to when we went from whale blubber to oil as our main energy source.
As an aside, I hated being dragged around museums as a child, but the Whaling Museum of Nantucket was an important exception and it really highlighted how energy trends shape the political and economic order. This is an example of an important disruptive trend which we aim to navigate for you through our active approach to managing money.
What should we expect in 2022?
Fund managers tend to have a fairly miserable disposition because, even when performance is strong, you inevitably worry about how you are going to generate return in the future. After such a strong year for markets, this concern is even more pronounced.
Last year, the vaccine announcements inspired confidence in a “reopening trade” which offered high returns with limited risks.
Looking at our models, we are now entering a more mature phase of the economic cycle when growth momentum peaks and central banks begin to withdraw support. Against this backdrop, we expect equity returns to be more muted but still positive, supported by solid corporate earnings.
Inflation is a popular theme, and we would agree that over the medium term we are likely to be in a more inflationary environment compared to the last decade. This is driven by rising wages, deglobalisation and decarbonisation. In the shorter term, we expect inflation momentum to peak as supply bottlenecks ease, but central banks will still raise rates.
At the stock level, it is important to identify those companies with pricing power given the risk to margins posed by higher input costs and wages, as these will be better placed to weather the storm. However, we do not believe that inflation poses a systemic risk for markets yet as the willingness of central banks to start raising rates in response to inflationary pressures should help to mitigate any sell-off at the long end of government bond yield curves. There is still a role for bonds in portfolios.
Covid-19 remains a concern
Covid-19 continues to cause volatility, with the latest variant, Omicron, renewing these concerns. It is important to step back and acknowledge that we’ve come a long way since the first quarter of 2020. Levels of immunity are considerably higher, even in the face of mutations; governments have become more experienced and react more quickly; and the processes of how to develop new vaccines are increasingly efficient and streamlined. Market participants have also developed a framework to consider the virus.
We have moved on significantly from the extreme uncertainty of early 2020. Nevertheless, Omicron has led to partial lockdowns and it’ll be a slow start to the year in terms of growth. In an ideal world, we would be seeing a strong synchronised global economic recovery, but the onset of Omicron makes this less likely.
The one area that could surprise is China where, unlike other major economies, policy is turning stimulative.
The private sector will have to take on the baton of growth
In recent years, we compared the global economy to a “wobbly bicycle”, where a lack of economic momentum left us vulnerable to being blown off course by any gust of wind. The pandemic forced governments to put stabilisers on the wobbly bicycle, allowing us some reprieve from cyclical volatility. Those stabilisers will be coming off in 2022 and the private sector will have to take on the baton of growth.
At the same time, rising rates will put pressure on the frothier parts of the market, prompting rotation and volatility.
The times they are a-changing, opportunities remain but the ability to be flexible and nimble will be key.
My more technical colleagues would describe the potential distribution of outcomes as “platykurtic”, a more muted upside with elevated risks. In more simple terms, diversify your risk - this is not a time for big bets.
The full CIO Lens is available below.