IT’S that time again. Dusting off the crystal ball, setting down the outlook for the next 12 months and plucking next year’s investment winners out of the air. If only it were that easy. The markets look a lot less obvious at the start of the year than they do at the end, with the benefit of 20:20 hindsight.
So, to share my seasonal pain, let me walk you through the first part of the process, deciding what the prevailing themes will be in the year ahead. Ultimately, this is the more important bit of the job because ultimately it’s the big asset and regional allocation calls that will determine whether its Krug or Blue Nun at the end of 2022.
Question number one: shares or bonds? This choice has been particularly important over the past 20 years or so because over that period the two have been negatively correlated. They have, in other words, tended to move in opposite directions on the same bit of news. What’s been a positive for shares has pointed to rising yields, which by a process of simple arithmetic implies a negative outcome for bonds.
Now it is possible that this relationship breaks down, and indeed there has been some talk of this recently. Over the past hundred years or so there have been more years when the two assets moved in the same direction than apart. But let’s assume that things carry on as they have for the past couple of decades. Who wins?
I’m pretty confident, given the high valuation of bonds and where we find ourselves in the middle of the economic cycle, that shares are the place to be for the foreseeable future. Yes, there is a long list of things to worry about as central banks prepare to take away the punchbowl, supply chains remain gummed up and the spectre of Covid continues to hang over markets. But earnings growth remains formidable, monetary and fiscal policy continue to provide a tailwind to investors, valuations are high but by no means excessive and sentiment is far from exuberant.
There is enough in that mix to encourage the belief that we remain some way from the end of the bull run that rose out of the wreckage of the financial crisis in 2009. The markets decided this week that the re-appointment of Jay Powell as chairman of the Federal Reserve marked a hawkish tilt for central bank policy. On the contrary, I think it points to more of the same - a desire to keep markets bubbling while the post-pandemic inflation spike works its way through the comparatives.
Which brings me to the second key theme next year. While I broadly agree with Mr Powell that most of the inflationary impulse we are experiencing today is temporary in nature, the same belief prevailed in the late 1960s and we know where that took us in due course. So, while continuing to believe equities are the place to be, I’m also looking to put some insurance in place against the possibility that the inflation hawks are right.
Looking back at the main inflation regimes of the post-war period there are some clear differences. In the 1940s, when the authorities were, as today, willing to tolerate rising inflation while keeping interest rates artificially low, shares were the only game in town because bond yields were capped and commodities held back by price controls. The big inflation boom of the 1970s was altogether different. Then commodities had a field day, with gold and silver, in particular, leading the pack. Gold has been a disappointment in the early stages of inflation’s latest return, but I believe it could have its moment sometime soon.
The third question I am asking myself today is where in the world to invest after a two-year period which has seen US stocks leave every other regional market trailing in their wake. The S&P 500 stands nearly 120% above its level in March 2020. And that builds on a long period of outperformance since the financial crisis. Will Wall Street continue to lead the charge? It could do but its dominance in the global portfolios with which I’m playing the first, risk-on theme means I don’t need any more American shares at this stage.
When it comes to relative valuations, the UK and Japan stand out for me. The London market is particularly weighted to the sectors that should do well as we pull out of the pandemic and is notoriously short of the technology shares that thrived during it. Oil and gas and banks in particular look like a sensible place to be during an economic rebound accompanied by rising interest rates and bond yields.
As for Japan, this is a market which barely registers with UK investors. Indeed, according to the Investment Association, it represents less than 3% of total assets under management in Britain despite being one of the world’s three biggest stock markets. Despite this, there are plenty of reasons to have an exposure to the Tokyo market. It is cheap, certainly by comparison with the US, it benefits from supportive fiscal and monetary policy, is increasingly shareholder friendly when it comes to dividends and share buybacks, is geared to a global economic recovery, and has leading positions in high-tech sectors such as robotics and computer gaming.
So, there’s the investment backdrop. A positive outlook for shares, a need for some protection against rising inflation, and some stand-out regional valuation opportunities to take advantage of. The next job is to pick the right investments to play those three themes. But that is for another day, another crystal ball.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
Share this article