After another positive year for Nutmeg portfolios, we turn our attention to the 12 months ahead, highlighting the macro and market challenges and opportunities that we expect will shape our thinking.
After the seismic shocks of the previous year, 2021 has been all about clearing the rubble as the global economy begins to learn how to live with and, to some extent, contain the spread of Covid-19.
Breakthroughs in vaccine development and a gradual reopening of businesses proved a huge boon to investor confidence with global equity markets on a largely upward trajectory over the course of the year. However, volatility later in the year amid fears around the Omicron variant shows how things can change very quickly, while the economic recovery has remained fragile in many locations.
Predicting the future health of the global economy and markets is never easy, with today’s investor having to weigh up not only the impact of the global pandemic, but also the influence of factors such as rising inflation, global trade bottlenecks, Brexit, and climate change.
Still, with a wealth of experience and macro data at their disposal, our investment team has set out six key themes that we believe will continue to shape investment markets over the next 12 months.
1. Inflation: What goes up…
Inflation in true economic terms is an ‘ongoing’ broad increase in prices – covering everything from groceries, to houses, cars, clothes, and toys – and a subsequent fall in the purchasing value of your money. It’s important to keep an eye on the factors at play.
The latest available data, as we write, showed the UK Consumer Price Index (CPI) hitting the highest level in a decade at 5.1% for the year to November, according to the ONS. In the US the rise was even more stark with year-on-year CPI up 6.8% in November, which represented the largest 12-month increase since November 1990.
Chart 1 shows the comparison to long-term average inflation (dotted lines) and current levels in the United States and United Kingdom.
Chart 1: Consumer Price Inflation, % over year ago
Source: Macrobond, Nutmeg
So, what is causing prices to rise, and can we expect inflation to continue to be a problem in the year ahead? Up until recently, we in the West have largely benefited from pretty slow price rises even as economies began to grow again after the financial crisis. But the pandemic and subsequent lockdowns brought a dramatic halt to this in 2020; factories closed, flights grounded, and people stayed at home; delaying discretionary spending.
While businesses have now reopened following the sharpest economic contraction on record, supply bottlenecks have arisen everywhere. To manufacture a car or mobile phone, for example, requires many different complex parts and suppliers. And as supply has been slow to come back online so shortages have pushed prices higher.
Couple supply shortages with a surge in demand as economies reopened and the effect is magnified. On the demand side, it’s worth nothing here that households have been supported by some of the largest fiscal stimulus programmes ever undertaken – the average American received $3,340 in stimulus cheques alone.
We believe these bottlenecks will continue well into 2022, however, we are now seeing the first signs that some constraints are easing; falling shipping container rates a case in point. Most likely, the supply-driven spike in inflation is likely to peak at some point during the year.
It’s also worth remembering the old truism ‘what goes up, must come down’, particularly pertinent for the historically volatile commodities markets. Impacted by geopolitics as much as it is by supply and demand shocks, spikes in the likes of aluminium, copper, crude oil, and natural gas may well prove temporary.
However, we do acknowledge that oil prices are a special case given the friction involved with moving to a low-carbon energy platform. Yet an upward drift is expected as economies open-up and continue to grow. It’s important to remember that inflation traditionally lags economic cycles by up to 18 months, and this means we expect normal cyclical inflationary pressure into and beyond 2022.
Another important area to keep a close eye on is US and Chinese trade relations. A key flash point under the Donald Trump presidency was the so-called ‘trade war’ between the world’s two largest economies, with trade tariffs still in place today that have resulted in higher prices on both sides. Ongoing change in the relationship between the US and China will shape the inflationary environment as well as the geopolitical environment. For example, US President Joe Biden may consider easing some China trade tariff restrictions in sectors such as industrials, materials, and consumer tech. This should ultimately ease upward price pressure.
We expect central banks to normalise short-term interest rates. Forward guidance (how and what the world’s major central banks communicate) suggests that they will soon begin the ‘hiking’ cycle to counter the inflationary threat. Indeed, in December the Bank of England was the first to move as it initiated its first rate rise in more than three years, up to 0.25% from 0.1%. However, we don’t expect prohibitive increases in central bank rates as policy makers will want to nurture the established recovery.
“We expect inflation to remain elevated relative to the pre-pandemic period over the next 18 months, even while the temporary price hikes due to supply bottlenecks ease off. We are keeping our fixed income exposure underweight those assets most detrimentally impacted by rising bond yields,” James McManus, chief investment officer
2. Globalisation: In short supply?
Supply shortages felt by us all during the height of the pandemic may prove to be symptomatic of a wider desynchronisation in the global economy. The UK like many other countries has grown to be heavily reliant on imports from other territories, particularly the EU and Asia.
We’ve written before about the growing rivalry between China and the US, and the prospect of a potential ‘decoupling’ of the two economies. China has a strong self-interest in staying engaged with the West even if it loses its historical supply-chain status; indeed, there are good reasons too for the US to help China develop its local economy, thus building a market for its products.
Still, with the pandemic no longer centre stage, we expect further jostling for seniority between the two superpowers to persist in 2022. President Biden has spoken about China’s “unfair” trade and economic policies harming American workers, while also highlighting human rights abuses in Xinjiang, Tibet, and Hong Kong.
China is changing its growth model to be more centred around its increasingly wealthy citizens. That’s undoubtedly a trend to flourish further in 2022 – especially given the Communist Party’s National People’s Congress.
From a global markets’ perspective, however, it’s the US that continues to be top dog. This is especially true within equities markets with US-listed companies making up c.70% of the MSCI World, the most recognisable index of the largest global companies (see Chart 2). It is home to the giant tech names which have held sway in recent years, identified in some quarters by the now somewhat dated acronym FAANGs: Facebook (now Meta), Amazon, Apple, Netflix and Google (now Alphabet).
Chart 2: MSCI World by region weighting
Source: MSCI, Bloomberg
With digital businesses less impacted by Covid than others, will these stocks continue to drive US equity indices to fresh highs in 2022? As professional investors, we are keenly aware of the valuations of indices measured by the price/earnings-to-growth (PEG) ratio, which gives market participants an estimate of whether an investment is over or under-valued relative to its peers (an example in the next section).
As managers of globally diversified portfolios, we have remained largely overweight the US in 2021. This is likely to continue into 2022 with our belief that it is home to some of the most robust, innovative and proven businesses globally. The US economy has also led the economic recovery in the developed world. Still, we are also ready to move quickly should fortunes change.
“Global businesses are becoming ever more digitised with technology enabled companies a key beneficiary of this trend; and so stock prices of companies who lead their peers in digital and technological transformation are likely to continue to experience outsized investment performance. Even China may become a more attractive investment opportunity as it challenges the traditional technological and market supremacy of the United States,” Brad Holland, Nutmeg director of investment strategy
3. Stimulus: Hey, big spender
In early and mid-2020, as it became clear to the world the damage Covid-19 was going to cause the global economy, so policy makers began to approve substantial fiscal and monetary measures of support. Most notable was the $2.2trn Coronavirus Aid, Relief, and Economic Security Act (CARES) passed in the US by former President Trump, while the Bank of England announced an additional £100bn in quantitative easing.
These responses were reactionary, ‘keeping the lights on’ for economies while trying to stimulate growth and returning confidence to financial markets. Having achieved that aim, 2021 policy turned towards meeting medium-term growth objectives. For example, on 15 November, President Biden finally signed his $1.2trn Infrastructure Investment and Jobs Act into law, promising vast sums into the nation’s roads, ports, bridges, and power lines. His promise to the nation? “America is moving again, and your life is going to change for the better,” he said.
Further legislation, the $1.75tn Build Back Better economic plan – which designates funds to the fight against climate change and the expansion of social spending in areas such as child care and education – is currently up in the air having been thwarted by fellow Democratic senator Joe Manchin in December.
President Biden knows he needs to appear strong on the economy, particularly with the 2022 mid-term elections coming in November 2022. Fresh spending will bring much needed infrastructure for transport – including charging points for electric cars – and better broadband in rural areas, which will give a boost to the broader economy.
This Infrastructure investment and Jobs Act plays out over the course of ten years, but we are encouraged that it could bring broader, more immediate funding across the States and not just major cities and financial centres on the east and west coasts. While taking a stance in support of blue-collar America can do no harm to Biden’s popularity, there are likely tough political challenges in 2022; funding for both this infrastructure bill and the $1.9trn American Rescue Plan. The President is pursuing tax hikes on corporate America and wealthy households but is facing tough opposition – including from fellow Democrats.
The UK Government’s own £4.8bn Levelling Up Fund also places emphasis on local economy growth with aims to regenerate town centres and improve out-of-city transport links. However, it’s not all good news with the recent decision to scrap HS2’s East leg causing much outcry – this would have supported an estimated 160,000 new jobs and stimulated a gross value-added uplift to the economy of £200bn. Still, Levelling Up is a big positive, in our view, with the UK economy needing to operate on all cylinders in the wake of Brexit. The latter has led to record-high vacancies in some industries as firms struggle to find skilled (and unskilled) workers. So training is back on the agenda in corporate Britain.
The FTSE 100, the UK’s preeminent equity index, remains far from a bellwether of the health of the UK economy. According to some estimates, around 75% of its constituent’s earnings generated overseas – it maintains an acute antenna towards global growth. As sterling-based investors, we believe it continues to make sense to maintain a strong weighting to the UK market, given the global operations of large UK listed companies. That said, we know UK stocks are less growth focused than many other developed markets, with low technology component and a leaning towards oil, gas, and mining.
Chart 3: PEG measure, 10-year z score
Source: Macrobond, Nutmeg
Still, UK stocks remain relatively cheap compared to other developed markets, due in part to ongoing concerns around the health of post-Brexit Britain (see Chart 3). With our natural investor base in sterling, our portfolios have a higher UK weighting than global indices (home bias). Within UK equities, we are favouring the FTSE 250 index, home to middle-sized more domestically orientated companies to benefit from strong labour market and the levelling-up agenda.
“In the UK we are emphasising the mid-sized companies of the FTSE250 index, as we expect the UK economy to perform well as service industries recover post-pandemic. Globally, our equity exposure is above normal levels, and it is largely pivoted towards the US. But as 2022 progresses, we expect to find other ways to access the benefits from continued global growth,” Pacome Breton, Nutmeg director of investment risk
4. Markets: All eyes on the Fed and BoE
Alongside equities, the second main component of all Nutmeg portfolios is a globally diversified mix of bonds. We remain underweight this broader asset class which has had mixed fortunes in 2021. Government bonds in particular fell from favour during the first part of the year as investors tended to fret about higher inflation and the scaling back of central banks’ bond-buying stimulus. Taking into account the eroding effects of inflation, the ‘real’ yields that earnt from government bonds are still deeply negative in major developed markets. Couple this with policy makers looking to raise interest rates, and we believe it makes sense to remain underweight this asset class.
For corporate bonds, yield spreads – the additional income offered compared with government bonds – have been close to their narrowest levels on record in the later stages of 2021 (see Chart 4), making these assets poor value from a historical risk/reward perspective. As with government bonds, we remain highly selective in the positions we hold, though still recognising the diversification benefits of holding fixed income assets alongside equities in a multi-asset portfolio.
Chart 4: US 10-year BAA corporate spread (basis points)
Prolonged strength of the current bull market in equities will, as ever, depend much upon the policy action (or inaction) from the central banks. The all-important US Federal Reserve (Fed) announced in November that it would begin unwinding its 20bn-a-month stimulus program. The real test for markets will come with interest rate rises – current expectations are for the Fed to initiate two hikes in 2022.
The UK’s Bank of England (BoE) was the first of the major central banks to start talking about raising interest rates, and acted in December with its move to 0.25%. The BoE was also earlier than many market commentators in expecting a healthy rebound in the UK economy, and 2022 is likely to prove them justified in wanting to normalise the extraordinarily low level of interest rates. We think an improving labour market and higher inflation will see the BoE pursue the tighter policy it sees necessary to balance the economic recovery and avoid more severe future inflation risks.
“Provided that forward guidance is open with no ‘surprise’ policy moves, we would expect markets to take any rate rises in their stride, recognising the need to keep inflation in check as well as recognising that healing economies can withstand – indeed need – higher interest rates,” Yang Yang, Nutmeg investment analyst, performance and risk.
5. ESG: Nascent trend or is there a bubble?
The past few years has seen an incredible swell in interest in socially responsible investing (SRI), as investors recognise the benefits of integrating environmental, social, and governance considerations (ESG) into their investment activity.
From a security selection’ perspective, SRI is about much more than just the obvious examples of clean energy and electric cars. As well as offering investors greater alignment with their personal values, it’s also about the use of new ‘non-financial’ data, alongside traditional financial measures, to help improve our understanding of the competitive dynamics between companies now, and in the future.
That means not just focusing on new growth industries, SRI casts a fresh light over more ‘traditional’ businesses, assessing their relative ESG characteristics. For example, our Socially Responsible Portfolios invest in established names such as graphics card manufacturer Nvidia, with its policies around mining of minerals; Microsoft, which has aims to be carbon negative by 2030; and pharmaceutical giant GSK which has made 13 commitments related to various UN Sustainable Development Goals.
2021 has been a strong year for many of these ESG leaders, and our portfolios. So, will this growth continue into 2022? Or is there an ESG bubble brewing as investors clamour for exposure to the companies deemed as industry leaders because of their ESG credentials?
While there are undoubtedly some sub sectors that have exhibited bubble like behaviour – clean energy stocks in early 2021 being one example – we do not believe there is a bubble on a broader basis and continue to see ESG themes as critical investments.
Of course, we need to be conscious of the bias of investors when it comes to selecting these ESG leaders, and the reliance of the global investment community on a limited number of strategies and research resources as the industry upskills itself in this fast-evolving sector. We would term this the ‘Lonely Planet effect’; likening it to the effect guidebooks have on the popularity of restaurants in a certain destination, and the potential pitfalls of herd mentality.
We think we are at a nascent stage in adoption of ESG investment. As the transition to a lower carbon economy builds momentum, we expect a vast reallocation of capital within financial markets. US investors, in particular, have been slow to adopt ESG investment principles, despite their relative size advantage. At the end of 2018, total assets committed by US investors to sustainable and responsible investment strategies were broadly the same size as Europe’s commitment, at circa 2trn, despite the significantly larger size of US capital markets.
Compare this to the assets under management of Principles for Responsible Investment (PRI) signatories by the end of 2018 (circa 2trn) and the gap is stark. In fact, 18 of the world’s largest 25 asset managers are headquartered in the US, and with an estimated 34% of investment assets being held by the top-ten asset managers globally, a shift in strategy from even one or two of these institutions could make a massive impact, providing a sustained tailwind for ESG leaders.
2021 saw a renewed emphasis on decarbonisation from governments globally through the COP26 Glasgow Climate pact. As such, we expect the continued growth in the green or climate bond market, especially as initial green debt issuance from governments such as the UK and EU has been met with overwhelming demand in 2021.
The fast evolution of the green bond market, from niche to a mainstream asset class of over trn in value in just over a decade, is an example of the speed of innovation within financial markets to address ESG goals. The Bank of England meanwhile has led by example, adjusting its corporate bond purchase scheme to achieve a reduction in carbon intensity and a long-term commitment to net zero.
We also expect a continuation in the shifts of consumer preferences towards sustainable products and an accelerated transformation of industries to provide investors an expanding opportunity-set.
“With the longevity of global environmental and social policy initiatives and structural societal challenges, such as climate change, ESG is an investment theme that will continue to dominate investors thinking in 2022,” James McManus, Nutmeg chief investment officer
6. Passive investing: An ever-expanding universe
At Nutmeg we have always favoured the use of ‘passive’ Exchange Traded Funds (ETFs) as a cost-efficient and effective way to track market indices. Meanwhile our Smart Alpha Portfolios, powered by J.P. Morgan Asset Management, provide a low cost and diversified investment approach with security selection at its heart by using innovative active ETFs.
The ETF universe has expanded to match exponential growth in investor interest. Data published by Bloomberg Intelligence in November show ETFs have taken in more than $1trn new assets in 2021, meaning they now represent circa 15% of all investment fund assets globally at just under $10trn of assets under management.
Chart 5: Global ETF assets (US dollar trillions)
Source: ETFGI data, 2021 data as at end of October 2021
We believe this growth trend will continue in 2022 as the ETF market matures and expands, opening more esoteric areas – such as sustainable investment paths.
The issue of potential illiquidity in certain investment asset classes, such as commercial property and some parts of the bond market, has also reared its head again in 2021. Stock-picking mutual fund managers often bear the brunt of this criticism should they ‘gate’ or close their funds to outflows, as investors trapped in UK property funds have once again found out to their detriment.
With this in mind, we continue to stick to our core investment principles and focus on asset classes (and ETF’s) that can be quickly and easily traded within our universe of global equity, bond and commodity markets. We remain open to investing in new ETFs as they unlock key markets for retail investors. Moreover, maximising our leverage as a large UK wealth manager, allows us to work with providers in creating new funds tailored specifically for our needs.
2021 has seen the continued growth of active ETFs, such as those utilised in our Smart Alpha Portfolios. These innovative investment products combine cost efficiency, transparency and diversification of ETFs with the best ideas of JP Morgan Asset Management’s global research team and seek to offer outperformance of the wider market.
We continue to believe that ETFs are superior to traditional mutual funds, offering our clients unrivalled diversification, transparency, and cost efficiency. As asset allocators, ETFs offer us a wide range of options to implement our investment views with over 1,000 ETFs listed on the London Stock Exchange alone; that choice can only continue to grow in 2022.
“The world of ETFs continues to be a thorn in the side of traditional fund managers, which often charge excessive fees resulting in the majority underperforming their benchmark indices. Still, we also recognise the benefits of disciplined security selection with our Smart Alpha Portfolios built specifically for investors who believe that in-depth stock selection can add to performance, but without the typical trade-offs in liquidity, diversification, and cost,” in liquidity, diversification, and cost,” Daniel Al-Hariri, investment analyst
We hope you have found our investment team’s 2022 outlook insightful and interesting. Although we believe these six themes are likely to have an influence on the year ahead, one thing that’s certain is that we live in a world of change and unforeseen events. So, as ever, the team will be closely monitoring current affairs and their potential effects on financial markets and will respond as required. You can keep up to date on all their latest views and portfolio updates at our Nutmegonomics blog hub.
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.