2021 has been largely characterised by the staggered re-emergence of markets and economies from the effects of the Covid-19 pandemic, and the return of inflation after decades of absence. We believe 2022 is likely to be a pivotal year in terms of the desynchronisation of fiscal and monetary policies, the effects of inflationary pressures, and the subsequent effects on certain asset classes. As the year draws to a close, we want to take the opportunity to look at some of the more persistent themes we have been watching and how they are likely to shape investments in 2022. 

US long-term interest rates 

The US long-term interest rate has always been, and remains, one of the most important rates to watch from an investment perspective. 

Most interest rates around the world are affected by the US interest rate as it is the one of the building blocks of many countries own rates and forms part which are used to value assets and discount their future cash flows - which is what we use to arrive at intrinsic value. A change in the discount rate therefore has a significant impact on the valuation of the different types of stocks and bonds in your portfolio. 

If rates go down significantly like we have seen in the USA, the PEs of long-duration (growth companies) equities rise more than that of higher yielding equities, and vice versa. However, rising inflation expectations will likely see increases in the Fed Funds rate of interest in 2022, and investors need to be mindful of the impact this will have on their investments. 

We remain convinced that global interest rates are still too low given the current strength of the global economy and rising inflation expectations. It’s becoming harder for central banks to argue transitory inflation as inflation is becoming more pervasive, particularly in the services sector of the economy. Many Emerging Markets have already started to push up their interest rates and the question now is: at what point will the central banks of developed economies pivot to a more restrictive policy.

Global fiscal spending amidst slowing growth – how will they pay it back? 

The reaction of governments around the world to the Covid pandemic and its effects was almost unanimous to support their economies through fiscal spending and monetary stimulus of unprecedented levels. This overwhelming level of stimulus has supercharged the valuations US equities but also other assets including residential property prices, art, fixed income, Bitcoin etc. 

This huge debt burden now sits on governments' balance sheets and there are ultimately only three ways to reduce the high levels of debt. The first option is to try repay the debt by raising taxes. We are starting to see a little of this in the US, but it wont move the needle. Secondly, governments could default, which we think is unlikely. And finally, governments could allow a period of sustained higher inflation over a longer period to reduce the levels of debt. We think this is the more likely scenario going forward. 

Inflated prices of long-term assets 

Returns in 2022 and beyond are going to be shaped not only by what investors own but also what they don’t own, and especially by avoiding some of the irrationally expensive assets like long-dated developed market bonds and some of the very highly valued “hopes and dreams” equities. We think staying invested in these assets is a sure way of loosing money for clients when the liquidity and monetary support is ultimately withdrawn. 

At Truffle we have tried to focus on identifying opportunities with a significant margin of safety and those assets with higher yields. We believe the direction of travel for the US 10-year rate is likely to be higher and we therefore want to avoid many of the expensive crowded long-duration growth equities as they will be much more negatively affected by rising discount rates. There are lots of cheap assets with higher yields offering investors outsized returns - particularly in South Africa, and its important to remember that investors still need exposure to equities in the long run, especially if we are moving into a period of higher inflation as this is the only way to protect the real value of their savings.