”We learn from history that we learn nothing from history”
–George Bernard Shaw
Friday 7th January, 2022
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To our readers around the world, we wish you all a very happy and productive new year! We hope that you enjoyed a restful (and Omicron-free) festive period, and we salute those of you who kept the world turning by working through the holidays. As ever at Bedrock, we are ready to hit the ground running in 2022, and we look forward to helping you navigate the coming months while sharing our thoughts on all the latest market news in these pages.
However, before we turn our attention to the present day, it is worth pausing to reflect on the year just past; and what a year 2021 turned out to be. Coronavirus lockdowns came and went as new vaccines and variants sparred for supremacy in a global arms race that culminated with the advent of the vaccine-dodging (but apparently quite mild) Omicron variant in late November. Meanwhile, inflation in developed markets reached its fastest pace in decades, and this forced central banks to pivot from an ultra-dovish monetary policy stance at the outset to a much more hawkish one by year-end. During the year, Chinese regulators also took it upon themselves to begin a major crackdown on all those inadequately deferent local tech companies that (apparently) exist in China, in addition to the for-profit education sector (which was more-or-less destroyed overnight in July). This continued even as China’s economy slowed sharply in Q3, and as property giant, Evergrande, teetered on the brink of collapse.
In addition to these broader trends, there were a number of truly shocking events in 2021 that deserve a mention. In the late summer, the two-decade long War in Afghanistan finally came to a disastrous end for the US, with the Taliban back in power in Kabul and Biden very much on the back foot at home. The speed of the US withdrawal that preceded – and precipitated – the collapse of the Afghan government, has caused considerable damage to US alliances and commitments around the world (to the benefit of great power rivals China and Russia). From Ukraine to Taiwan, the chaotic scenes at Kabul airport will be remembered for years to come. And they may yet encourage bad actors to escalate brewing conflicts around the world.
Also shocking (albeit on a somewhat different scale), in January, we saw a number of large hedge funds betting against GameStop go belly-up in the world’s largest ever short squeeze. Remarkably, this was precipitated by vigilante bedroom traders coordinating through online forums, a new phenomenon that sent shockwaves through Wall Street. (At one point on 28th January, GameStop was up +2464% for the year despite nothing fundamental having changed about the business…). As trading becomes easier and cheaper for your average Joe, sudden price spikes and asset bubbles are becoming more common; and we are about to find out what that means for markets as liquidity is withdrawn.
Finally, heading further back in time, who could forget the bizarre manner in which 2021 began. On the 6th of January the US Capitol was besieged by a scantily clad shaman and other supporters of the Q-Anon conspiracy theory in which Trump (helped by well-known buddy Robert Mueller) will soon seize power at the head of a military government in order to flush out an international network of cannibalistic devil-worshipping paedophiles that control events. We are waiting with bated breath…
Financial markets, meanwhile, saw considerable dispersion and bouts of elevated volatility in 2021, as investors grappled with a fast-moving macro backdrop and crippling pandemic uncertainty (particularly when the Delta and Omicron variants first emerged). As harsh winter lockdowns were gradually lifted in the northern hemisphere in the first half of the year, business and consumer activity rebounded, labour markets tightened, inventories plummeted, commodity prices soared, core and headline inflation rose sharply, and market expectations for future interest rates began to drift higher. However, for many months, almost all of the major central banks refused to budge on monetary policy despite the changing environment. They were understandably fearful of what tightening monetary policy too early – or even changing their dovish forward guidance – would mean for the nascent and uncertain global recovery. However, the ever-growing disconnect between market expectations for interest rates and central bank guidance, created an uneasy dynamic for all investors who had benefited greatly from the vast injections of liquidity provided by central banks throughout the pandemic. The disagreement between the market consensus and the views of policymakers – which hinged on how persistent high and rising inflation would prove – together with the immediate twists and turns of the coronavirus pandemic, fought for control over the prevailing market narrative throughout the year. As a result, there were frequent equity rotations across sectors, styles, and regions, and there was much higher interest rate volatility in 2021 than in previous years. Developed market bond yields and equities had risen strongly by year-end, but the trajectory was by no means linear. Meanwhile, there was a major divergence in outcomes between precious metals and all other commodities as the latter soared due to supply chain bottlenecks and rebounding demand just as vaccine-driven optimism and rising yields weighed on gold and silver.
But there now appears to be a less ambiguous macroeconomic outlook emerging, not least because the Omicron variant seems to be milder (but also much more infectious) than Delta. The minutes from the December Fed meeting show that policymakers and markets are (finally) aligned in the course that they expect rates and growth to take going forward. Both expect the recovery to continue in 2022, and for there to be three policy rate hikes during the year (with a March hike being a distinct possibility). The Fed then expects to pursue a faster pace of balance sheet reductions than it did in the last cycle, and for this quantitative tightening to begin soon after the first hikes are made. In response to the minutes, yields have risen this week, and technology stocks have suffered from a rotation into less rates-sensitive sectors. We think that this convergence trend is likely to continue given the considerable inflation pressures that remain and the wide valuation gap that exists between value/cyclical and quality/growth stocks. Therefore, as we look ahead, we continue to preach diversification as essential to avoid a medium-term re-rating of equity portfolios that would otherwise be excessively skewed towards high growth stocks. Commodities are another area that we like today as we expect energies and industrial metals to benefit from the growth recovery, while agriculture is helped along by low crop yields and supply issues in many places. Finally, long duration fixed income is one to avoid in our view. Policy rates are undoubtedly set to rise in the coming months, while QT (when it comes) will provide a negative technical backdrop in treasury markets. We also favour a volatility and inflation hedge in our portfolios, in the form of gold, on the off chance that central banks get into trouble or Russia invades Ukraine! Welcome to 2022.
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