Macro Matters January 2022

(Source: Merlea Macro Matters)

Summary

The emergence of the Omicron Covid variant has reminded us of the uncertainties which remain around the global pandemic. Despite this, I expect 2022 to be another good year for growth as the global economy continues its recovery. I do, however, see growth cooling following an exceptionally strong 2021, as the massive support offered by governments and central banks during the pandemic’s initial stages begins to fade.

We start the year with economies held back by a supply chain crisis and the rapid spread of the Omicron. According to the Centre for Economics and Business Research (CEBR), a UK thinktank, the global economy is still expected to grow by about 4% in 2022, compared with an estimated 5.1% in 2021.

Future policy responses are likely to be more restrained in terms of size and more focused on cushioning the supply side rather than fuelling another surge in demand. This follows from (a) the lessons from earlier policy measures, (b) a different starting point in terms of inflation and (c) limitations from using a lot of firepower over the last two years. For instance, the US government is unlikely to use the approach of sending significant transfers to households, while boosting unemployment benefits to levels that in some cases exceeded in-work income. This had the effect of both turbo-charging demand and limiting labour supply.

The European approach of in-work support might be preferable, though it can have the side effect of creating rigidities. Meanwhile, the Fed will be constrained by worrisome inflation trends. High government debt levels, without a big buyer of Treasury securities may also restrain the extent of the fiscal response.

In the Eurozone, the ECB will likely be less constrained by inflation concerns, though it may not feel the freedom it did in 2020 where the starting point for underlying inflation was much lower. In addition, while the PEPP (Pandemic Emergency Purchase Program) is not officially constrained by issuer limits, the 50% threshold may still provide some constraints. Has Omicron exacerbated supply issues and therefore inflation?

The supply side looks very likely to be adversely impacted if Omicron proves to be a more dangerous strain than its predecessors. Manufacturing and transportation could be impacted by a combination of direct restrictions and the disruption to labour supply. The zero-tolerance policy of the authorities in China and some other Asian countries certainly points in this direction. Of course, this would come at a time where the various supply-side bottlenecks globally are already severe, with long delivery times and a record gap between orders and output in major manufacturing economies such as Germany.

Source: Refinitiv® Datastream® as of 21 October 2021. YOY = year-over-year.

I believe the year ahead will be dominated by efforts to fight inflation along with climate change, while global economic growth will be reasonably strong and stock markets weak. The biggest issue facing policymakers around the world, especially in the US and the UK, is likely to be inflation. The Bank of England unexpectedly lifted interest rates in December after a rise in inflation to a decade high of 5.1% and signalled that more rate rises will follow in 2022 as soaring energy costs are expected to push inflation to 6% in the spring. The US Federal Reserve has pencilled in three rate hikes next year and accelerated the rate at which it cuts spending on government bonds in the face of what one official called “alarmingly high inflation”.

In the face of higher interest rates and the rolling back of quantitative easing, bond, equity, and property markets are expected to fall around the world, with global declines ranging from 10% to 25%, and some of the impact to last into 2023.

Bonds

In 2022 the expectation is for policy to tighten and yields to rise, and variations of the terms “rising rates” and “higher yields” appear throughout. With bond returns expected to be negative Treasury yields are pushing higher at the fastest new year pace in 20 years. At its December meeting, the US Federal Reserve left policy rates unchanged, near zero, while signalling a willingness to hike as many as three times in 2022 to combat inflation. It also announced an acceleration in the pace of the taper that could see the asset purchase program end by March.  Once this occurs, the Fed expects to begin raising rates, with an additional three increases pencilled in for 2023 and two more in 2024. This would bring the Fed Funds rate close to its estimated neutral level, where monetary policy is neither easy nor tight, of 2.5%.

But what do rising rates mean for bonds? Consider the last seven hiking periods. The Bloomberg US Aggregate Index declined in only two of those periods and averaged a nearly 4% return. Those two periods, with low single-digit losses, were also a far cry from the double-digit corrections stocks often experience. Core bond funds provide a critical function in a balanced portfolio. First, they offer diversification from equities. That is especially important at a time when the stock market is hitting new highs.

Uncertainties, such as slowing global growth, an unknown COVID trajectory and a weaker Chinese economy, could result in heightened volatility. Surprises are possible, so avoid making big bets on long-duration assets.

The direction of long-term Treasury yields depends on how the Fed responds to current inflation. The Fed is accelerating its removal of liquidity because inflation has broadened, which has the potential to push 10-year yields higher. But the FED must be careful not to act too aggressively, which could derail the economic recovery and cause a recession. I think remaining flexible and willing to adjust duration as the year progresses is the best course of action. Active core bond managers can work to identify bonds with maturities that could hold up relatively well should rates drift higher. They can also invest in inflation-linked securities to combat rising prices.

US 10-year yield since 2001

Rising yields tend to be most positive for cyclicals. The prospect of higher bond yields also has implications for different industry groups. Cyclical industries generally outperform the broader market when economic growth strengthens and yields rise, while defensive industries outperform when economic growth weakens, and yields fall. For example, banks, energy, and materials have historically outperformed when yields have increased.

I maintain our neutral outlook in emerging market (EM) bonds but am closely watching the rising risks. EM central banks have been raising rates since the spring of 2021, moving sooner and faster than DM central banks. Russia, Brazil, and Mexico are key EMs that have already hiked rates multiple times due to soaring inflation and falling currencies. The risks are high for EM bonds. Slowing growth, rising inflation, and weaker currencies will continue to weigh on EM bond performance in 2022. Spreads are set to end the year significantly wider than where they started, reflecting investors’ demand for compensation for these risks.

The good news is that the worst of the inflation headache should be behind us. In particular, the surge in headline and core inflation has been driven by particularly strong demand for goods amid shutdowns in services sectors and disruptions to supply chains. I would expect that goods-related inflation will cool as demand for physical goods ebbs and supply chains start to catch up. In the meantime, consumers’ increased comfort with in-person interactions is likely to accelerate the shift in spending toward services such as entertainment and travel. Finally, the winding-down of government pandemic-spending programs, which provided a substantial fillip to household budgets, should ease overall demand.

Listed Property

While there are hopeful signs for a return to normalcy in 2022, recent days have also brought the unhappy possibility of more health-related uncertainty, which may continue economic and social disruption The emergence of the new Omicron variant of COVID-19 in late November 2021 serves as a reminder that the threat of new waves of infection looms over all aspects of the global economy. Increasing vaccination rates and natural immunity due to prior infection may help contain these risks. Assuming COVID-19 variants remain largely in check, this will be a period of economic growth that will drive recovery across a broad range of real estate and REIT sectors.

Inflationary pressure to the macroeconomy from the effects of supply chain interruptions will likely lead to moderate inflation levels over the next year, rising above the Fed’s target of 2.5% but likely well below historically high levels seen in the 1970s and early 1980s.

For investors looking for inflation protection in their portfolio, REITs have historically performed well during periods of moderate inflation in terms of market returns and operating fundamentals. REIT returns and operating performance have been higher on average in moderate inflation periods compared to low inflation periods. Early indications from the past two quarters suggest REITs are likely to perform well if we enter a sustained inflationary environment. REITs provide reasonable protection against inflation because rents are not as sticky as other prices. Long term leases typically have inflation protection built-in, and shorter-term leases are based on current price levels. Also, REITs keep a portfolio of leases, a portion of which are negotiated every year, so even REITs with longer-term leases have opportunities to reprice. Finally, as owners of real assets, REITs typically enjoy an appreciation in portfolio value along with the price level.

Potential areas of strength for the year ahead include industrial facilities across North America, the U.S. residential sector and cell towers, data centres in Asia and office REITs in Europe offer some opportunity. One of the biggest risks for REITs is monetary policy missteps.  Should central banks become more aggressive fighting inflation (significantly tightening monetary policy), this could create a headwind for equities (REITs included).  Yet if rate hikes around the globe are slow and if there’s “healthy economic growth,” then real estate investors are likely to see top line revenue growth outpacing higher debt costs that typically come with rising rates.

A-REITs have bounced back strongly after a significant decline in FY20 when COVID-19 first hit. A-REITs have been such a resilient sector over the years because they always know how to reinvent themselves and how to best mitigate risk. Given the considerable upheaval across the sector from COVID-19 already, and now with new variants emerging, I expect further adjustment to disruption in real estate.

The so called “reopening trade” has yet to materialise due to the continued impact of new variants, most recently and again disruptively the Omicron variant. So, this will again hurt those sectors that are reliant on open borders both domestically and internationally particularly the tourism and education sectors that are dependent on both.

The longer the disruption, the greater build-up of a desire to return to normal and I suspect travel (international in particular) will be the biggest beneficiary here with accommodation hotels being the biggest winner. Other outperformers will continue to be the healthcare and logistics sectors and sentiment towards office will remain subdued as the necessity to work from home during periods of significant community transmissions persist. However, when sentiment overrides reality some great buying opportunities could arise from oversold positions.

With structural shifts continuing to put pressure on retail and office earnings and the tight pricing in the direct markets for favourable assets, such as industrial and long WALE, many of the REITs (DXS, SGP, VCX, MGR, GPT, GOZ, SCP and AVN) have shifted towards active earnings, such as development and funds management, to generate growth. Out of the 8 REITs that have flagged their ambition to grow their fund’s management businesses, DXS has been the most active thus far in winning the management rights for the AMP Capital Diversified Property Fund, taking over the listed APN Property Group (APD) and forming a partnership with Australian Unity in their Healthcare Fund. These transactions have increased DXS’s FUM by 60% to $25bn, making it the third-largest real estate fund manager in the sector after Goodman Group at $58bn and Charter Hall Group at $52bn.

Other REITs, such as Vicinity (VCX), have started a strategy to shift from being pure retail landlords to a broader real estate business with mixed-use developments and new funds management initiatives. VCX anticipates that they can grow this from 10% of earnings to 20% over the next ten-year period. Whilst these initiatives are seen as positive, it will take several years to build a track record and investors are unlikely to pay a premium for these earnings.

Several large-cap REITs are currently trading below appraised book values, which creates a take-private opportunity for an acquirer. Privatising a REIT has the added benefit of stamp duty savings and being able to inherit an entire operating platform with management expertise.  The amount of capital pushing into superannuation funds and various alternative fund managers means they have the resources to consider elephant-sized deals of a scale that were previously not possible. In the infrastructure space we have seen large cash proposals to acquire Sydney Airport and AusNet Services, and something similar in the real estate space is possible given the amount of capital available to be deployed for defensive assets.

Listed A-REITs currently have very healthy balance sheets and are actively looking for growth opportunities coming out of the pandemic (especially in the real estate funds management space). Outside of a few large-cap REITs, most other REITs now have strong currencies to use in strategic mergers and to undertake equity raisings to acquire assets or businesses.

Australia

Easing of lockdown and border restrictions, along with a stimulatory federal election, I see a strong demand recovery through 2022.  The Australian economy will continue to recover quickly from the lockdown headwinds of 2021, with easing restrictions being met with strong demand from both consumers and corporates. Economic analyst are upgrading their 2022 GDP growth forecast to 4.9% on the back of this strong reopening, with 2023 growth also expected to stay above trend at 3.3%.

Government policy will be an important driver of economic activity this year. With a federal election due March or May, I would expect both major parties to propose deficit-expanding policies which should support broader sentiment.

Another key factor will be the easing of international border restrictions, particularly for temporary migrants, which have historically driven Australia’s net migration. Chris Read, Research Economist says, “We assume a faster recovery in net migrants, increasing by ~150k in 2022 (~0.6% of the population) before normalising to ~250k in 2023 (0.9% of the population)”.

For inflation, loosening global supply constraints and strengthening domestic demand see price growth relatively steady in 2022 (core inflation 2.3% year on year) before picking up more noticeably in 2023 (2.7% year on year).  The Reserve Bank of Australia (RBA) continues to stay dovish even as inflation persists in its target band. Economists expect further macro-prudential tightening to be announced in the second half of 2022 as household leverage moves to record highs as well as quantitative easing (QE) tapering to resume in February 2022, dropping from A$4 billion a week to A$2 billion until May, which is broadly in line with the US Federal Reserve. These measures allow the RBA to remain patient in terms of rate rises, although it’s expected to ease a quarter earlier than previously expected.

Along with above-trend economic growth, it is expected that the labour market will continue to tighten, even when incorporating the increased labour supply response from the easing of international borders. Morgan Stanley economists expect unemployment to decline to 4.2% by the end of 2022 and 4.0% by end of 2023, which are near historical lows.

Private sector demand is projected to be strong in 2022. Consumer income will be supported by the anticipated tight labour market, with excess savings and elevated asset prices seeing the savings rate fall below average in 2023.

However, many of the risks for Australia depend on the supply side of the economy. Continued supply chain disruptions and slower easing of international borders would lower GDP growth and increase inflation but on the flip side, a more aggressive migration program designed to catch up on lost population growth would represent material upside for economic growth.

Furthermore, the key demand-side risk lies in over-tightening of policy, an earlier than expected shift in fiscal focus to surpluses as well as faster rate hikes from the RBA would see a sharp reversal in sentiment and spending intentions from both consumers and corporates.

The health of the Australian property market is always a key talking point for investors and here we see the current strong environment continuing for at least another two to three quarters. While new loan commitments appear to have peaked and the Australian Prudential Regulation Authority (APRA) has recently introduced its first macroprudential controls, I think we are still in the best phase of the property cycle. Only if rates rise much faster than in our base case scenario is the property market likely to become a significant headwind for the Australian economy.

I believe we are entering a new phase of the market cycle – the “deceleration” phase characterised by slowing economic and earnings growth. This phase also typically see’s late cycle behaviour, such as increased corporate activity.

With equity markets hitting new highs monthly and economic risks rising I am becoming increasingly cautious. Reflecting our near-term caution, I increasingly favour quality and the more defensive areas of the market such as healthcare, staples, and utilities. I’m less keen on domestic and global cyclical names that have outperformed in 2021. Overall, I see the market environment in 2022 as being suited to quality defensive companies. An interest rate environment where rates are low in absolute terms, albeit with the first hikes expected later in 2022, may not prove to be such a big headwind for growth stocks.

Global markets

Markets are currently having to grapple with the competing issues of economic growth deceleration and persistently higher-than-expected inflation caused by ongoing supply chain disruptions and by excessive demand stimulus. This is occurring while central banks around the world are gradually starting to remove their emergency level pandemic support, such as tapering their bond buying programs. Slowing growth is a headwind for earnings, particularly for cyclicals and value stocks. Conversely, supply chain issues leading to stubbornly high inflation and rising bond yields in 2022 would be bad for highly valued growth stocks due to the impact on valuations. The latter is more of a risk than a central scenario in my view, since I believe the impact of slowing growth will be the factor that will matter more to investors in 2022. Supply chain disruptions will eventually be solved, even if it takes a bit longer than many expected.

America

Pandemic or endemic? Transitory or systemic? Hawkish or dovish? Shortages or restocking? Employment surge or shortage? The coming year is likely to provide clarity to questions such as these, which have muddied the waters for most of the last two years. The problem is that many of the answers are likely to only come in the latter half of the year, meaning that both the macro backdrop and financial markets might be headed for a choppy couple of quarters before establishing a clear direction.

Indeed, I expect the year to begin with the uncomfortable combination of sticky, high inflation, and a moderation in growth before transitioning to a higher growth profile with more moderate levels of inflation in the second half of the year.

Despite the headwinds created by monetary and fiscal policy withdrawal in 2022, there are parts of the U.S. economy that I expect will continue to perform well: Manufacturing production, capital expenditures, and business spending still look strong for the next several quarter. 4% real GDP growth in 2022. Inflation remains a focus for investors. Moderating demand, rebalancing demand (from goods to services), and a healing supply side of the economy should allow U.S. inflation rates to soften in the second half of 2022 to approximately 5%.

Elevated wage inflation and exceptionally strong labour demand are the key risks to this forecast. Fixed income markets have latched onto the higher inflation theme and now price a 98% probability of Fed lift-off in 2022. IO believe the risks are skewed toward a later lift-off and, eventually, a higher equilibrium interest rate than currently priced. If this is correct, the U.S. yield curve has the potential to re-steepen modestly, and the 10-year U.S. Treasury yield can end the year near 2%. Business surveys so far remain unambiguously positive, and while I would expect a deterioration in these leading indicators in the coming months, their lagged effects generally imply a brisk pace in the sector and would be supported by a few quarters of inventory rebuilding. Similarly, the housing market remains at very tight levels—rising personal incomes, still-low interest rates, and consumer behaviour all indicate that the existing dynamic is likely to persist for several months to come.

A more domestic source of uncertainty is the ongoing labour shortage. Employment dynamics were distorted by extended unemployment benefits for the last two years, which created a dearth of labour as the economy reopened. As these benefits rolled off, affected claimants should re-enter the job market.

The biggest incremental drag next year comes from fiscal policy. Even if President Biden’s Build Back Better full infrastructure package is passed, its per-year stimulus impact pales in comparison to the lumpy COVID-19 rescue bills in 2020 and 2021. All in, expect the U.S. economy to deliver 4% real GDP growth in 2022.

Europe

The euro area’s outlook remains solid as high-frequency indicators hint at impressive levels of economic expansion while medium-term growth expectations continue to be revised upward. Near-term challenges relate to the evolution of the pandemic and individual member countries’ (varying) approach to containment—most notably the strict policies deployed in Austria and Germany.

Financial conditions remain supportive of growth; however, a reversal in trend seems likely, and I am watching intra-European bond spreads closely as ECB officials debate the future of the central bank’s asset purchase program in the context of hotter than-expected inflation.

The ECB is enjoying considerable success with its forward guidance so far as markets abstained from pricing in a normalisation of policy rates, which remain in the negative territory, thereby delivering a clear divergence in relation to the Fed. Political risk in the first half of 2022 will likely be dominated by the French presidential election, as incumbent Emmanuel Macron is challenged by a resurgence in support for traditional parties as well as popular figures on the far right of the political spectrum.

Europe’s exposure to financials and cyclically sensitive sectors such as industrials, materials and energy, and its relatively small exposure to technology, should benefit these markets as covid variant fears subside, economic activity picks up and yield curves steepen.

United Kingdom

The United Kingdom’s medium-term growth outlook remains solid, with healthy levels of growth expected in 2022 and improving prospects for 2023 despite ongoing uncertainties.

Economic activity indicators such as Purchasing Managers’ Indexes (PMIs) are holding up remarkably well. Near-term risk will be tied to how the next phase of the pandemic plays out and its impact on consumption—specifically, consumer spending on services.

Inflation remains a threat to real consumption; however, both goods and commodities inflation is expected to moderate heading into the second half of 2022. Services inflation should receive increasing support from a tighter labour market that seems to be adjusting to the end of the government’s furlough scheme. I will be keeping an eye on the official policy rate, with 50 basis points. (bps) being a key level. Should it rise above that level, the BoE—based on its previous communication—could tighten monetary policy by opting not to reinvest proceeds from maturing debts on its balance sheet. The upcoming gilt maturity schedules suggest the BoE may have an opportunity to do so in March. If this were to happen, it could have important implications on growth prospects.

UK equities have lagged the global rally in 2021. Sector composition continues to be a headwind, and the technology exposure of the FTSE 100 Index is amongst the lowest of developed markets. The index is the cheapest of the major developed equity markets and offers a dividend yield of close to 3.5% as of November 2021. It has the potential to outperform in a global cyclical rally as fears around inflation and COVID-19 ease.

Japan

Japan’s economic data continued to surprise to the downside in the past three months, and the emergence of the Omicron variant presents added uncertainty to the outlook. With inflation largely contained, the Bank of Japan (BoJ) is set to keep monetary policy loose for longer, even as other central banks start to tighten.

Fiscal policy also remains supportive—among the highlights of Prime Minister (PM) Fumio Kishida’s recent supplementary budget was the allocation to domestic industry and digital investment, including a ¥400 billion funding for a new Taiwan Semiconductor Manufacturing factory.

Crucially, the budget was underpinned by new capitalism, a key policy proposed by PM Kishida, which seeks to achieve a more even distribution of wealth, with a specific focus on economic national security. Even though this initiative won’t alleviate near term semiconductor shortages, economist believe it demonstrates a shift in the government’s mindset toward building economic resilience and should help drive strong capital expenditure growth in coming years.

I am keeping an eye on the extent to which the recently introduced household subsidies will boost household consumption. It’s unclear how much of the subsidies will be saved and how much will be spent while the economic climate remains uncertain Consumers are sitting on excess savings, and the catch-up in vaccination rates will encourage more mobility and spending, A pick-up in business confidence, and the structural challenges with an ageing demographic, should see businesses increase investment.

China

Chinese economic surprises have started to improve relative to expectations and hopes of policy easing have buoyed sentiment. That said, headwinds to economic growth remain strong—from intermittent lockdowns disrupting domestic activity, particularly services, to continued power shortages and production caps on energy-intensive sectors and weakness in the property sector.

In my view, any policy easing will at best cushion, rather than prevent, the continued loss of economic momentum. The People’s Bank of China (PBoC) has continued to tighten monetary policy—its balance sheet has shrunk from over 40% of GDP to between 30% and 35% of GDP, reducing its size to nearly half of what it was in 2009.  Economic consensus growth forecasts for China have been downgraded in earnest in recent weeks and would expect further cuts materialise.

The path back to trend GDP, I believe, looks increasingly challenging. The recent Central Economic Work Conference suggests efforts to control debt and rein in the property sector will continue. In my view, policy support will remain measured and insufficient to prevent the economy from slowing further.

If the Omicron variant proves harder to contain than Delta, I would expect the government to introduce tighter containment measures that will negatively affect the services sector and global supply chains. Investor sentiment remains negative amid elevated regulatory risk and the limited hedge against likely stagflation based on the composition of the MSCI China Index. I would expect Chinese A-shares to outperform H-shares due to relatively less intervention risk.

Will the South China Sea Spark the Next Global Conflict?

China appears to be accelerating its campaign to control the South China Sea and the Senkaku Islands in the East China Sea. China’s ongoing militarisation of many artificial features in disputed waters is well known. A less well known, but highly consequential implication of this militarisation is the vastly increased capacity it gives China to project power not only to control the reefs and rocks of the South China Sea, but, in the future, to assert control over the high seas and airspace above it. A military conflict in the South China Sea would force most shipping from Europe, the Middle East and Africa destined for Asia and the US west coast to be diverted around the south of Australia. The additional shipping cost would bring reductions in economic activity around the world, but with dire effects on countries at the epicentre. The countries most exposed to economic loss from a regional maritime conflict are already spending more on their militaries. About 80% of global trade is carried by sea and estimates of the volume carried through the South China Sea range from 20% to 33%.

Commodities

Going into 2022, I’m expecting the disruptions we have seen in supply chains to improve, while the balances for several commodities will look less tight than in 2021. This should mean that prices edge lower from current levels. But importantly, market commentators still expect them to remain above long-term averages.

There will also be several macro headwinds, which should limit further upside for the commodities complex. Firstly, central banks are set to tighten monetary policy over the course of 2022. Secondly, a stronger US dollar next year. Finally, there are lingering concerns over the Chinese property market. If there is a further slowdown within this sector, it will likely put downward pressure on the complex, particularly for metals. However, the risk of this occurring is looking less likely as it appears the Chinese government is becoming a little more accommodative when it comes to policy.

The balances for most metals also look relatively better next year, which suggest that prices will edge lower from current elevated levels. They are still, though, expected to remain above their long-term averages. Inventories are low amongst several metals, whilst sentiment around the outlook for demand in the medium term is constructive due to growing investments in green projects, which happen to be metal intensive.  I am most bullish about aluminium going into next year.

The aluminium market is heading into a period of structural deficits and there is no quick fix to resolve this; I’m expecting to see prices trading higher.

I would expect agricultural commodity prices to ease through next year but again they’ll remain above long-term averages. The wheat market has traded to multiyear highs due to weather hitting crops from several key producers. Assuming normal weather in 2022, wheat should see ending stocks edging higher. There is uncertainty for sugar and coffee going into next season with La Niña weather risks building in Brazil. The coffee market has already suffered from drought and frost damage. How much of an impact this will have on next season’s crop will depend on precipitation over the rainy season? Given the uncertainty, coffee prices are likely to remain elevated until the market gets a better idea of how big Brazil’s next crop will be.

So overall, while there may be some marginal downside risks across the commodities complex in 2022, on a historical basis prices are likely to trade at elevated levels for another year. The key risk, of course, is the coronavirus pandemic

Gold

Precious metals are likely to struggle the most over 2022. Tightening from central banks around the world, along with expectations of further USD strength should mean investment demand for gold remains poor. The only scenario where I see further upside for gold prices is if central banks doing a U-turn on tightening. A potential catalyst for this would be further severe waves of Covid-19. Gold analysts believe $1,970 is the key resistance for the year 2022 with support at $1,580 per ounce.

Oil

Oil is set to see strong supply growth from non-OPEC nations, which coupled with a further easing in OPEC+ supply cuts should push the global oil market back into surplus. This should put a cap on prices. However, worries over OPEC capacity and the broader lack of investment in upstream production will likely also provide a floor to the market not too far below current levels.

 

Sector 12 Month Forecast Economic and Political Predictions
AUD 72 -75c

AUD has benefitted from Australia’s energy-exporting industry (around 20% of all exports), but we expect natural gas and coal (Australia’s second and third biggest exports) to be among the main victims of the energy price decline in 2022.

AUD will remain under pressure amid a steady rise in US Treasury yields as traders brace for a more aggressive monetary tightening by the Federal Reserve.

The latest Fed minutes revealed US policymakers considered quicker interest rate hikes and discussed quantitative tightening this year to tame persistently high inflation. The firm hawkish stance pushed US bond yields higher, hurting stocks and risk-sensitive currencies. Meanwhile, the Reserve Bank of Australia has repeatedly insisted that a hike in domestic rates is not likely until 2023, or until inflation pushes sustainably within its 2-3% target range

Gold $US1500-/oz- $US1800-/oz

Hold

Sentiment across precious metals remains pervasively negative, as highlighted by months of continued liquidations of ETF holdings.

Comparing the current business cycle to previous ones, inflation numbers are way higher and look sticky. This should keep real interest rates deep in negative territory in 2022.

The prospect of sustained higher inflation could lift hedging investments in gold in the short term, and that could increase the prospects for an earlier hike and faster tapering.

Commodities BUY

The aluminium market is heading into a period of structural deficits and there is no quick fix to resolve this; this should see prices trading higher.

A significant number of commodities will enjoy strong demand growth on a 20-year horizon and can be dubbed the ‘Commodities of the Future’. They are copper, nickel, aluminium, lithium, cobalt, tin, rare earths, metal scrap and green steel.
 

Property

BUY

Most developed countries have achieved high vaccination rates, and therefore are likely to maintain or resume the reopening of their markets if the Omicron variant turns out to be not as severe as expected.

 

The reality is that many investors had already factored in an eventual increase in rates from the ultra-low levels we had seen in the last 2-3 years, and therefore the yield spread to bonds had been steadily increasing up until this year.

Notwithstanding the normalisation in rates, we are seeing now, the relative returns generated from real estate are attractive by historical standards and should support valuations.  A stable regulatory and political environment that sits on the doorstep to Asia Pacific.

 

Australian Equities

Buy 7200- 7900

Reflecting my near-term caution, I am increasingly favoured quality and the more defensive areas of the market such as healthcare, staples, and utilities.

Expect a short term pull back.

Australia has been relatively resilient throughout the pandemic and will remain a preferred geography in which to invest, work, and study. Australia is currently in a transitionary phase, and as the borders open, we are likely to see the emergence of significant trends, such as a pick-up in travel given stifled demand.  Companies have delivered an encouraging reporting season and will increase their investments as the economy recovers.
 

Bonds

I prefer inflation-linked bonds as I see risks of higher inflation in the medium term. I recommend to be underweight duration on a tactical basis as I anticipate gradual increases in nominal yields supported by the economic activity.

High yield and investment grade credit are expensive on a spread basis but have support from a positive cycle view that supports corporate profit growth and keeps default rates low.

The risk of rising interest rates is only one aspect of a debt investment, and this risk can be easily addressed through managing duration exposure in the portfolio. As a result, I believe the benefits of maintaining a well-diversified, carefully targeted exposure to debt investments will be an important component of a portfolio, even in the current interest rate environment.

 

Cash Rates On hold Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.10%.
Global Markets
America Stand Aside

Elevated stock and bond valuations, corporate and government debt at high levels. Investors can expect more speculation about a market correction in the year ahead.

The S&P 500 hasn’t seen a proper correction since the bear market in early 2020. A decline of 10% to 20% has occurred about once every 19 months, on average, going back to 1928.

While I remain optimistic about the country’s medium-term outlook, short-term uncertainties, and lower liquidity levels (because of central bank normalisation) temper my optimism somewhat. U.S. stocks appear expensive relative to their history, based on price-to-earnings (PE) ratios. This gives some pause. Although market commentators still expect U.S. equities to produce positive returns, there will be increased volatility due to these factors.
Europe Neutral Weight  

Preferred countries UK and Germany.

The greatest uncertainty, though, is outside the EU’s borders in the shape of Putin. He has already flexed his muscles by reducing then restoring the gas supplies on which Europe, and Germany in particular, are so dependent. The threat of a Russian invasion of Ukraine hangs in the air.
Japan Accumulate 

Japanese equities typically outperform when global liquidity falls.

I would expect Japanese equities to outperform. This market is generally undervalued versus its global peers, and I foresee support for Japanese stocks coming from the economic reopening. Foreign investors have had limited their exposure to this asset class for some time.

 

China  Buy

The country’s economic growth is being driven by both the policy and liquidity cycles, and monetary tightening has peaked. As such, I expect to see improvements in liquidity conditions.

I am expecting higher growth for China’s economy and a possible rebound for its equity market. Macro trends in China remain broadly favourable, although bouts of Chinese market volatility of the type we’ve seen in 2021 are likely to recur, and geopolitical flare-ups are to be expected
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