In focus

CIO Lens Q2 2022: time to do the opposite of the last decade?


I have been endlessly fascinated by political, social and economic trends. Right now, I believe that we are now in the middle of a period of profound global change on many levels.  

Climate change is making it imperative that the world develops a more sustainable growth model.

Income inequality and its negative consequences have been exacerbated by the effects of quantitative easing.

The vulnerability of global supply chains has been highlighted by the Covid-19 pandemic and the war in Ukraine.

These three factors are leading to an intense focus on de-carbonisation and a reassessment of the risk of global supply chains, as well as much greater levels of government intervention. The impact on how we need to invest is far-reaching.

Commodities - pulled in opposite directions

From an investment perspective, we need to step back and focus on the medium-term implications of the Russia-Ukraine conflict.

This translates as more supply disruption across a broad range of commodities and a greater focus on Europe’s energy security. Coinciding with a global focus on net zero targets and the energy transition, this means that commodities and resources markets are being pulled in opposing directions.

Right now, there is a case for owning commodity-related investments as a hedge against inflationary pressures. However, we should also be investing in the energy transition which, more than ever, remains a strategically important area.

In many instances, through an active approach, we believe we can identify investments which serve both objectives.

Impact of rising rates

Then there is the prospect of rising rates in the face of rising inflation.   

We’ve previously talked about how with interest rates at zero the old proverb of “a bird in the hand is worth two in the bush” became untrue. That’s because the bird in the hand (cash or bonds, for example) was worthless, so investors were forced to invest in riskier assets (the two in the bush) to generate returns. However, rising rates now pose a challenge to returns from risk assets. That is, the "bird in the hand" starts to be worth something.  

While the last 10 years have been characterised by tight fiscal policy and loose monetary policy, this status quo is set for a turnaround. With a more interventionist approach from the government being accelerated by the pandemic and geopolitical conflict, we are seeing a return to looser fiscal policy and tighter monetary policy.

Bonds - moving from red to amber

Bond prices have fallen dramatically over the last few months, with the US 10 year yield rising from a low of 1.20% in 2021 to more than 2.50%. Similarly, the yield on the US credit index has risen from 1.75% to 4.5%.

Percentage changes such as these haven't been since the 1980s. At these levels, we would argue that the traffic light for bonds is moving from red to amber. What prevents us from getting more bullish is that investors will require more yield to compensate for the increased volatility.

Equities - look below the surface

Equity markets have bounced back from oversold levels as investors have become more accustomed to pricing in the risk of the war in Ukraine. Although the news is bleak, we now have more information on the reaction functions of Putin and NATO. However, the risk of an even more significant escalation can't be discounted.  

At index level, we expect equities to be caught between the cross-currents of rising interest rates and commodity prices leading to the expectation of more muted returns this year. However, below the surface we still see opportunities for more value-oriented investments. Looking at the last 20 years, there is still plenty to go for with this trend.

Time to invest the opposite way to the last decade

In short, it is a time for investors to consider what they did in their portfolios over the last 10 years - and then do the opposite. Investors need to take a forward-looking approach, and to expect the unexpected.

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