After a period of surprising outcomes for both equity and debt markets, both of which have reached record prices even after the global instability caused by COVID-19, what does next year hold?
In this M&G Investments 2022 outlook Q&A, Jim Leaviss, CIO, Public Fixed Income joins Fabiana Fedeli, CIO, Equities & Multi Asset, and Maria Municchi, multi-asset Fund Manager, to discuss key issues at the forefront of investors’ minds. Questions include whether inflation is transitory or more permanent, the likely rate hikes from major central banks, and if the high prices of risk assets – whether equities, corporate bonds or high yield – are sustainable.
Inflation and unemployment rates
Jim Leaviss: If you’d have asked me a couple of years ago where the 30-year bond yield would be if inflation in the US was over 6%, I certainly wouldn’t have said below 2%.
Fabiana Fedeli: This has been an incredibly surprising rise in equities, and one thing I have learned over many years in the equity markets is never to take them for granted. At this point, there are three key considerations. The first is that it has been a period of extremely divergent performance. For example, from a country perspective, the US has had an incredible rise versus the rest of the world. This divergence has also been true of stocks within the same sector, which means there are still a lot of opportunities – but also the need to stay selective. The second consideration is that, yes, it’s true that equities are expensive versus their own history. But compared with non-equity asset classes, they’re actually relatively reasonable. And, if you look at the amount of liquidity still around, that remains very supportive for equity markets.
Jim Leaviss: The Fed seems to be more worried about the unemployment rate than it is about inflation – despite the fact that the market is talking about two rate hikes from the Federal Reserve in 2022 – and yet the unemployment rate is coming down every month.
Maria Municchi: I think it’s very interesting, because obviously there’s a huge focus on inflation at the moment, but the Fed mandate is also to promote maximum employment, and when we look at the US labour market today, there are some very interesting areas that are worth monitoring in the coming months. For example, yes the unemployment level is now relatively low, but some ethnic minorities as well as younger workers are still suffering a very high level of unemployment. Also, the participation rate is much lower than it was before the pandemic. This equates to around 5 million people having not re-entered the workforce as yet, which highlights a level of slack in the US labour market. Finally, we’ve seen strong evidence of wage growth over the past few months, but it’s still very much focused on lower wages and younger employees. So it’s very important to look at the US labour market in the context of the current inflation picture, because it’s another element that the Fed will take into account when deciding its future monetary policy. As it stands today, we see a Fed that is supportive of a strong, but also inclusive, labour market.
Where are investors looking?
Jim Leaviss: When I think of the type of assets within fixed income that might do well in this kind of environment, I like inflation-linked bonds and Treasury inflation-protected securities, because they will protect you to some extent when inflation is rising. The other thing that works well for me in this kind of environment is emerging market bonds. As always, there’s going to be a lot of risk and volatility when investing in emerging market debt, but that probably looks to us to be the best place for value in fixed income at the moment.
Fabiana Fedeli: From an equities point of view, the overarching consideration is that there will be areas that continue to do well, areas that will do even better, and those that will perform very poorly. We have to be aware that the polarisation that has been true of equity markets over the last year or so will continue and might take a different direction. So there are opportunities, but also a need to stay selective. Areas that we don’t like are obvious – those where inflationary pressures will hurt companies, or companies that are part of supply chains with a lot of cost pressure and without the pricing power to pass it on to their own customers.
In terms of areas that we like, from a sector perspective I would highlight global infrastructure. Real assets do well during an inflationary period, and particularly now we’re having a strong push on infrastructure spend. This includes the renewables sector – where we expect to continue to see a lot of opportunities. However, we have to make sure that we invest companies that are able to pass cost along and have solid balance sheets, in order to withstand the impact of variable rates.
