its This time again. Take the dust out of the crystal ball, set the forecast for the next 12 months and get the winners of next year’s investments out of the air. If only it were that easy. The markets look much less clear at the beginning of the year than at the end, with a 20:20 advantage in retrospect.
So, to share my seasonal pain, let me guide you through the first part of the process, and decide what the prevailing issues will be in the coming year. Ultimately, this is the more important part of the job, because ultimately these are the big readings of assets and regional allocation that will determine whether the Krug or its blue nun by the end of 2022.
Question number one: stocks or bonds? This choice has been particularly important over the last 20 years or so because during the period there was a negative correlation between the two. In other words, they tended to move in opposite directions in the same knowledge. Which in the process of simple calculation implies a negative result for the bond.
Now this connection may be breaking down, and indeed it has been talked about recently. Over the last hundred years or so there have been more years in which the two assets have moved in the same direction than separately. But let’s assume things continue as they have in recent decades. who won?
I’m pretty sure given the high appreciation of the bonds and the place where we find ourselves in the middle of the economic cycle, that stocks are the place to be for the foreseeable future. Yes, there is a long list of things to worry about as the central banks prepare to take the punchball, supply chains remain lit and Cubid’s spirit continues to hover over the markets. But earnings growth has remained tremendous, monetary and fiscal policies continue to provide a backlash to investors, valuations are high but by no means excessive and sentiment is far from abundant.
There is enough in this mix to encourage the belief that we are staying away from the end of the running stamp that emerged from the ruins of the 2009 financial crisis. Markets decided this week on the reappointment of Jay Powell as chairman of the Federal Reserve a sign of a hawkish tendency towards central bank policy. .
Which brings me to the second key issue next year. Although I generally agree with Mr. Powell that most of the inflationary impulse we are experiencing today is temporary in nature, that belief prevailed in the late 1960s and we know where that led us in the future. So, although I continue to believe stocks are the place to be, I’m also looking to set up some insurance against the possibility that inflation hawks are right.
Looking back on the major inflation regimes of the post-war period there are some clear differences. In the 1940s, when the authorities were willing, as they are today, to tolerate rising inflation while keeping artificially low interest rates, stocks were the only game in town because bond yields were limited and commodities stopped by price controls. Was completely different.So there was a field day commodity, when gold and silver, in particular, led the bunch.Gold was a disappointment in the early stages of the last return of inflation, but I believe it could get its moment sometime soon.
The third question I ask myself today is where in the world to invest after a period of two years in which US stocks leave every other regional market following them. The S&P 500 stands at almost 120% above its level in March 2020. And it is based on a long period of good performance More since the financial crisis.Will Wall Street continue to lead the charge? It can do but its dominance in the global portfolios with which I play the first issue, the risk-on means I do not need any more US stocks at this point.
When it comes to relative valuations, the UK and Japan stand out for me. The London market is particularly weighted for sectors that need to succeed when we emerge from the plague, and is notoriously lacking in the technology stocks that thrived during it. Oil and gas and banks in particular seem like a sensible place to be during an economic recovery accompanied by rising interest rates and bond yields.
As for Japan, this is a market that is barely registered for investors in the UK. Indeed, according to the Investment Association, it represents less than 3% of total assets under management in the UK despite being one of the three largest stock markets in the world. Despite this, there are plenty of reasons for exposure to the Tokyo market. It’s cheap, certainly compared to the US, it enjoys a supportive fiscal and monetary policy, is increasingly shareholder – friendly when it comes to dividends and repurchases, aims for a global economic recovery, and has leading positions in high – tech sectors such as robotics and computer games.
So, there is the background to the investment. A positive outlook for equities, the need for some protection against rising inflation, and some notable regional valuation opportunities for exploitation. The next job is to choose the right investments to play these three issues. But it’s for another day, another crystal ball.