Forecast 2022: Challenges and opportunities across the investment landscape

The year has started with a lot of nervousness, as global markets are sitting on a jittery edge. The previous year’s tailwinds are now increasingly looking to act like potential headwinds for the global equity markets.

The Fed’s extraordinary stimulus coupled with the accommodative monetary policy served as a significant factor for last year’s massive gains across all the risk asset classes.

Similarly, the fiscal largesse provided by American and European authorities provided a solid cushion for the unemployed and lower-income groups. As we come out of the shadows of the pandemic, both these factors are likely to provide significant speed brakes on last year’s massive rally. Inflation will loom large for a lot longer, with supply chain issues hampering recovery-related growth.

Despite all the past challenges, the year ahead will likely provide pockets of opportunities in various ways.

TOP CHALLENGES

01 – Navigating choppy waters alongside the central bank rowboat
For global markets’ investors, a lot depends on the ability of the central banks to walk the middle ground. An outrightly hawkish Fed will likely lead towards a path of more uncertainty and volatility. The markets’ worst-case scenario will likely involve a further sustained correction across all the risk assets.

02 – Sky-high valuations in specific sectors
Having closed the first month’s trade, markets look to further discount the possibility of more interest rate hikes. This is especially dangerous for the top US tech growth stocks. With the Nasdaq Composite Index being corrected by 10 per cent already, a sustained consolidation towards the downside could trigger more fear and panic even amongst seasoned equity investors.

03 – Chances of more flare-ups in Covid-19 variants
If the last 18 months are any indication, chances of discovery of new mutants and variants of Covid–19 are extremely high. While the previous Omicron variant is said to be much less dangerous than the highly
infectious Delta variant, the world of virus mutations and its treatment is 100 per cent unpredictable. This will likely imply more negative triggers for any short periods of calm and complacency. Even the 1918 Spanish Flu had multiple waves.

04 – The year when ‘uncertainty will be the new certainty’
Global investment markets are currently saturated with multiple headwinds ranging from central bank actions, pandemic ill effects and overvalued markets, among other factors. The expected volatility derived
from the implied volatility index (or VIX) curve levels has remained relatively higher last year, near 20 per cent. Compare this with the 27 per cent returns observed in the benchmark SPX–500 index last year. The risk to reward is almost moving linearly, implying enough warning signals ahead for the markets.

05 – Inflation is not transitory
Contrary to the entire narrative being built up last year by central bankers and economists of inflation being transitory, the current rise in inflation trajectory is proving out to be stickier than previously expected. From supply chain snags to sudden demand outbursts in the post-pandemic recovery phase, the roots of inflation are firmly anchored to the ground, as seen in the current cycle. This is also the number one reason why the Fed has suddenly started its shift towards a hawkish tone.

TOP OPPORTUNITIES

01 – Pivot towards Steepener trades
Markets are currently battling out the expected rise in key US interest rates. What the US does with its money markets and bank rates has enormous repercussions on the global economy. A look at the current
Eurodollar futures contract shows the gravity of the entire interest rate rise episode.

The rolling three-month Eurodollar futures have corrected from a high of 99.82 seen in July 2020 to the current lows of 98.61, implying the market expectations of a massive shift in interest rate trajectory.

Time is ripe to enter products trades that are highly correlated with an interest rate rise. This includes sectors such as financials, which have historically remained strong in a rising rate environment. Concentrating on a shorter-maturity bond portfolio with decent yields avoids the risk of being too exposed to a significantly longer duration.

02 – Return of value investing 
Some of the best-performing stocks in 2021 were the previous year’s laggards. Energy sector stocks such as Halliburton (24 per cent), Chevron (10 per cent) and Aviation major Boeing (8 per cent) have outperformed the top names in the Nasdaq-100 as well as the FAANG index. Value investing as a theme might get further impetus with the sudden shift towards higher interest rates and ongoing move towards the ‘recovery and reopening’ theme.

03 – Despite the ongoing sell-off, growth stocks will dominate the average investor’s mindset
Legacy growth names that are part of the benchmark US indices have a built-in business model that is hard to replicate by anyone. These tech companies also drive the global economy through physical devices or onsite/offsite products and services. The current dip can be seen as more of a technical adjustment by the markets discounting the new normal. This likely implies balancing out the inefficiencies and high valuations in the overstretched markets.

04 – Blockchain and AI see growing relevance
Blockchain and cryptocurrencies went through a massive paradigm shift in 2020-21. What started as a fad is now slowly catching the average investor’s interest. So much so that despite the over 50 per cent correction currently seen in cryptos, most institutional investors are still looking to diversify to legacy cryptos, including Bitcoin and Ethereum. The growing relevance of decentralised finance (or DeFi) and non fungible tokens (or NFTs) is seeing more optimisations and consolidations across the blockchain space. Use case-specific and competitive cryptos – such as Solano and Polygon – are likely to see a new wave of investors based on the underlying sentiment in the crypto markets.

Artificial intelligence (AI) and cloud computing are also in focus. Almost every major industry in every corner of the world is leveraging the power of AI and increasing their physical and network infrastructure to either complement the work being done by humans or replace it outright by providing a superior level of skillsets and competency.

As per the latest survey from Gartner, more than 80 per cent of the firms surveyed in the technology and service space expect their AI investments to top $1m over the next two years. While exploring primary use cases of AI remains in a very nascent stage, its broader adoption and integration will likely see more traction and value addition in this field.

05 – ESG investing will continue being in the spotlight
The increasing frequency of extreme weather events and events related to social justice have contributed to the elevation of ESG issues as the top priorities for investors, companies, and policymakers. According to Refinitiv Lipper data, $649bn flowed into ESG-focused funds worldwide by November 30, 2021, up from $542bn and $285bn, respectively, in 2020 and 2019.

As a result, ESG funds now account for 10 per cent of worldwide fund assets. Additionally, the number of US companies voting in favour of ESG proposals has increased from 21 per cent in 2017, to 27 per cent in 2020, to 32 per cent in 2021.

Vijay Valecha is the chief investment officer at Century Financial 

Taken from GB Invest February 2022 edition