2022 has been the year that kept on giving – especially when it comes to shocks and volatility. As we get closer to the end of the year there are some crucial areas of uncertainty that will significantly affect investment outcomes and portfolio asset allocation decisions over the next 12 months. Trevor Garvin, Head of Muti-Manager at Nedgroup Investments outlines these concerns below. 

1. At what level will US inflation finally settle? 

When last can one remember US inflation being higher than that of South Africa. This has not been the case for several decades. For the last 40 years, US inflation has averaged around the 2.5% mark. However, inflation is currently around the 8%-9% level – a level that has caught the US Federal Reserve off-guard and sent shock waves through world markets over the past year. 

With the Fed aggressively hiking interest rates to try to regain control of inflation, there are differing schools of thought when it comes to predicting where it will land. 

Some commentators feel inflation will in time again stabilise around the 40-year average of 2% - 2.5% within the next 12-18 months. 

Others feel inflation will settle at a structurally higher level of 2.5% - 4%. This would then have several material knock-on effects – it will affect things like retirement planning and the discount rate for equity valuations. There is the added dimension of a very tight US labour market (US unemployment remains at record low levels) and it is feared that this may drive wages higher which will further fuel inflation or delay the time that it takes for it to fall back to the levels that the Fed is targeting. The difference between these two ultimate inflation outcomes will create uncertainty in the interim causing increased levels of market volatility as investors price in differing potential outcomes. 

2. The impact of deglobalisation 

There have been several large shifts in foreign policy amongst the larger economic powerhouses of the world. The Trump presidency was one of the first obvious indications of a renewed focus on nationalist economic policies. “Make America Great Again” was his slogan – with much emphasis on moving the production and manufacture of strategic goods and services back to within US borders. 

The unexpected war between Ukraine and Russia has also been a stark reminder to countries of the need to be able to defend themselves and their borders. Spending on arms and defence, an area that historically governments look to cut back on when fiscal expenditure is tight, they now realise they cannot compromise. NATO is more unified and stronger than ever working towards protecting western European borders. Germany, along with several other large European countries, who were reliant on Russian gas and energy, have speedily looked to conclude agreements with several other energy suppliers as well as to build their own capabilities. High energy prices and not controlling one’s own energy sources has led to increased countries following a more isolationist approach. Renewable energy projects have been speeded up which is good news towards reducing carbon emissions by 2050. China’s domination in many areas of manufacturing has caused major supply chain disruptions, affecting industries from car manufacturing to mobile phones and pharmaceuticals. There has been a shift in government thinking – accepting that the world is a global network and trade needs to occur, but also being self-sufficient in strategic centres is equally vital. 

3. Ways of working have changed 

Hybrid working arrangements are being introduced in companies across the globe. This has had an impact on the way that business, travel, office spaces, property management and even housing works. Office spaces in some major capitals of the world are being modified into residential areas, whilst storage, distribution and logistics warehouses are in major demand. The airline industry is buckling – having retrenched up to 70% of their workforce, and now struggling with the global surge in demand for air travel. Different sectors have been affected differently and this will continue to evolve which again will have important implications from an investment perspective. 

There has also been a large shift within corporates towards focussing on the mental wellbeing of staff. Post Covid, there is a desire for a more balanced lifestyle with greater flexibility and a holistic approach to one’s health being the focus. 

4. Central Banks are changing their stance 

After more than a decade of quantitative easing, central banks are taking a different approach. Coming out of the global financial crisis in 2010, central banks added about 10 trillion US dollars onto their balance sheets as they pumped money into the system to help prop markets up and maintained artificially low interest rates. They had just started normalising rates in 2019 when in March 2020 the Covid pandemic hit and forced central banks to once again step in and double their balance sheets by adding another 10 trillion US dollars to keep economies afloat. 

However, in the last six months rapidly rising global inflation and a policy of ‘quantitative containment’ from central banks has resulted in a reverse of direction. Central banks around the world have rapidly and sharply raised interest rates – with more rises still expected. In addition, they are no longer injecting billions into the economy but rather reducing expenditure and budgets. This is a massive change and one that will certainly remain top of mind for the investment industry in the coming year. It is widely expected that consumer spending will be hit hard, with lower earnings growth for corporates in 2023, and likely recession for the next 12-24 months in many first world economies. 

5. ESG, Climate Change and the fall out from conflict 

ESG (Environment, Social and Governance) has been a big topic and a major area of concern in the investment world for some years already as the drive towards carbon neutrality gained momentum. We have just had Cop 29 conclude in Egypt with many countries committing to the targets set via the Paris Accords in 2015. The invasion of Russia into the Ukraine and the subsequent effect of skyrocketing energy prices has been a setback for climate change policies. Some countries have been forced to revert to coal for power generation whilst looking for alternative sources of gas and energy. Positive effects have also been seen, with several new major renewable and clean energy projects being fast tracked. Without doubt there is increasing pressures and focus on corporates to have strong governance and policies that are environmentally friendly. Issues like this will have an impact on their future ability to raise capital and at what cost. There is also a shift across companies to not purely focus on profit maximisation – but rather have a dual focus – that of profit with a purpose, doing good for the greater society. 

6. Geo-politics and global economies 

The UK had three different prime ministers in 3 months between August and November. The impending US elections (and recent mid-terms results) are keeping everyone guessing and the tensions between the conservative right and the more liberal left within politics seems to be at an all time high. China has had severe lockdowns in place to enforce their zero Covid policies. On-going war in Ukraine causes uncertainty and tensions between the West and East. Food and energy shortages with inflation effects has spiralled. Lower forecast global growth and possible recession. 

In short, there are many uncertainties on investors’ minds that have a direct impact on investments. It is very difficult to know how all these major issues will unfold over the next 12-18 months – which makes it extremely difficult to allocate capital. At times like this, ensuring you have a diversified portfolio is critical – one that can withstand the impact of differing outcomes. 

7. Higher regulation and the impacts on new businesses 

In a recent Thompson Reuters survey of over 1000 businesses, the volume and implementation of regulatory change was cited as the biggest issue affecting business owners. The increase of regulation across most industries, including financial services, is directly affecting the formation of new companies and listings. The major cost of implementing this heightened regulation becomes a barrier and discourages entrepreneurship. This in turn can be harmful to economies as new businesses are one of the keys to healthy economic growth and rising employment. 

Conclusion 

The outcomes of these issues will remain uncertain and will materially affect what investment returns will be for the next 12-24 months. This of course impacts the way that decisions will be made in the investment industry – by both asset managers and investors alike. Very often it is in times like this that the best opportunities can present themselves. Valuations is ultimately what drives investor returns, and it is when uncertainty and anxiety is at its peak that one needs the courage to allocate capital to cheaply valued assets. It is in times of turmoil and uncertainty that very often real value appears and great investment opportunities occur. One needs to have the conviction to invest, whilst at the same time ensuring one has a well-balanced and diversified portfolio. Markets move in ever changing investment cycles and this too shall pass.