Fresh into a new year, tapering of monetary support and global economic issues mean we’re expecting a bumpier ride for risk assets, but long-term supportive trends remain very much intact.
2021 was overall another good year for risk assets coupled with benign market drawdowns. While Covid-related fears did cause some investor angst, realised volatility in global equity markets was only around 10%, significantly below the long-term average of 15% (see Chart 1).
In our view, there is a clear potential for volatility to creep higher in 2022 as central bank monetary policy support – particularly the buying of government bonds – is gradually eased back by the likes of the Bank of England, Federal Reserve, and European Central Bank.
Back to normality
This extraordinary period of extreme accommodative monetary policy that started in March 2020 with the emergence of the Covid pandemic has had the indirect consequence of dampening volatility. With this support being reduced, it wouldn’t be a surprise to see volatility higher – back to more normal levels. For investors, this may mean bigger fluctuation in the value of their portfolios on a daily, weekly and monthly basis compared to what they saw in 2021.
Chart 1: Global world equity – yearly volatility (annualised)
Source: Macrobond, Nutmeg, MSCI All Country World (Developed & EM Markets 2001-2021)
As per Macrobond and Nutmeg data, during 2021 there were only two calendar months (September and November) when equity markets lost more than 1% globally, which is particularly mild. A typical multi-asset balanced portfolio had a maximum intra-year drawdown of around 3%, significantly lower than the median of the past 20 years which was in excess of 6%. It wouldn’t be a surprise to us to see 2022 intra-year drawdowns more in line with the long-term average (see Chart 2).
Chart 2: Yearly intra-year drawdown of simulated multi-asset portfolio
Source: Macrobond, Nutmeg, MSCI World All Cap Index (Developed Markets 1995-2021)
With regards to absolute return expectations, 2021 saw double-digit returns in most equity markets besides the emerging world. We were rightly optimistic despite the Covid restriction early 2021 that equity markets had the potential for a compelling year. The potential for 2022 is probably more muted, given the impact of the Omicron variant on restricting future global growth in a world of higher inflation and less accommodative policy makers.
Geopolitics could well take centre stage this year with heightened tensions between Russia and Ukraine, and further risk of escalation of trade spats between China and the US along with the Middle East. The spectre of a potential Russian invasion of Ukraine in the coming weeks, which has been widely speculated upon in the press, would have severe ramifications in the short term for markets and would be especially disruptive to energy supplies. However, even if volatility was to spike in the short term it is not entirely clear if this would create sustained negative headwinds for corporate earnings in the US or other developed countries.
Reasons for optimism
While it is easy to focus solely on the potential negative headlines, there also remain supportive trends for risk assets even if the trajectory in 2022 might be less linear.
Firstly, despite the tapering of monetary support, the developed world will likely remain in a very accommodative policy environment. While the Bank of England may have surprised many with a modest rate increase in December 2021, citing higher inflation forecasts, forward guidance points towards a maximum 1% base rate by the end of 2022, which would match 2019 levels.
The US Federal Reserve has also become more hawkish but, even with three potential hikes in 2022, rates would remain well below long-term average. It is clear to us that central banks will tread carefully with terminal rates likely to stay low.
Inflation is expected to remain between 3% to 6% among developed economies for at least the first few months of 2022, which suggests to us that equities remain the most attractive asset class compared to bonds. With short-term rates close to 0% and likely to remain below 1% in 2022, lower-risk assets like cash and short-term bonds will return far less than the level of inflation with global and diversified equities one of the few asset classes with the potential to preserve capital in the face of inflation.
With the vaccines now widely available in Europe and other developed countries providing some level of protection and hopefully helping to restore the previous status quo, it is easily conceivable that global growth will resume strongly in the second quarter of 2022. This would be highly supportive for corporate earnings and margins, and ultimately supportive for risk assets
Powerful forces at play
Overall, it seems highly possible that 2022 will see a return to normality for the volatility of risk assets compared to what was experienced in 2021. Expectation for a repeat of last year with double-digit returns in equity markets and limited volatility and drawdowns is probably misplaced, or at least optimistic, and expectations should be dampened as 2021 was a particularly attractive year in all aspects.
There are however still powerful forces at play, particularly historically low real interest rates, potential for above average GDP growth in developed markets, low unemployment rates and sustainably high corporate earnings, which will be all supportive for risk assets and equity markets despite a less favourable environment. We will be managing the portfolios to efficiently balance the potential for positive returns and incorporate macro-economic changes and further developments in world economies and markets.
Risk warning
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.
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Pacome Breton
Pacome is an investment manager and head of risk at Nutmeg with more than ten years' experience in investment and risk management. He previously worked for a US family office and a large European asset manager and started his career at Société Générale in Tokyo. He holds an MSc in quant finance from Bocconi University in Milan and is a certified financial risk manager and chartered alternative investment analyst.Other posts by Pacome Breton
