January 14 2022

The Playbook Starting 2022

The beginning of the year felt more like a punch in the stomach, than a kiss. Part of it is the devil we know, a great deal of us have been affected by covid one way or another, and this has wide ramifications even if short-lived. Health issues, lockdown, work impairment, school disruption, complex logistics, social behaviour disfunction….well, more stress in the end.

Fair to say that the economy has been fairly well compensated for that. The flipside of inflation running red hot, at 7% year-on-year in the US, was formidable wage increases of 4.5% yoy. What at first glance appears like a shortfall of 2.5% was in fact corrected by (a) wages increasing more for under-privileged population, and (b) asset inflation compensating wealthier asset holders.

The devil we don’t know is the one that has most of our interest, for it is the one that markets attempts to price. It might appear contradictory at first to see USD weakening, as interest rates increase. Indeed, markets have almost fully priced the 3 to 4 rate hikes with current 10-year treasury yield at 1.75%, by selling USD bonds, and somewhat pivoting away from US equities. In 2022, economists expect the US growth giving up its leading role in the global recovery and plateau-ing after 2Q22. On the flipside, European growth might strengthen and emerging markets could appreciate the relief from a weaker dollar.

The global investment flows are therefore going away from US and getting invested outside, putting further downside pressure on the USD. This is probably a good thing for US trade, but also reinforcing inflation trend. Where this would stabilize is hard to tell, but at present investors are selling momentum and high-beta stocks, such as US tech & crypto, and pivoting into defensive staples & value companies.

The eye of the storm is most certainly the out-of-favour “innovation stocks”, which were targeted by Cathie Wood’s ARK funds. The squeeze played on the way up with retail-fuelled $20BN cumulative flows peaking in April21, which flooded the market caps of a selected few, making the fortune of the likes of Tesla. Now that the founders sold at peak, such investments are puking hard, as investors and companies alike pray that they were not on ARK’s roaster. In retrospect, ARK would probably go down in history as the biggest pump-and-dump scheme, something #WallStreetBets would only pale in comparison with.

Our two cents on how 2022 is going from now, is that returns on quality bonds would be negative. US stocks overall would deliver ~5% return. Emerging markets would benefit from slight rotation outside the US and a weaker USD. By sector, tech is a mixed bag of necessary valuation re-adjustment, and the affirmation of an ever-increasing market dominance. Alternatives will enjoy a field trip, with increasing access to inflows from retail investors. But remember, only a diversified portfolio will protect you against many possible outcome.

360 Advisory – Markets