A time of changes – the investment year 2022

In a longer historical context, the past few years have been an exceptional time on the investment market. The 2008 financial crisis was the starting point for a new kind of operating environment, the characterising trends of which have only strengthened in the euro crisis in 2011 and further in the early days of the coronavirus crisis in 2020.

We are accustomed to an exceptionally light monetary policy of central banks, whether it concerns interest rates for short-term financing to commercial banks or direct securities acquisitions on the secondary market. We are also used to a slower economic growth and very low inflation. This is despite the fact that the volume of money in circulation in the economic system has been constantly increasing in relation to the national product. The monetarists have been cornered over the past decade.

Afterwards it has been easy to state that the period has been exceptionally favourable from the investor's point of view. It has been difficult to lose money on a portfolio that has even the slightest diversification by asset class and type. The yields have decreased (bond prices have risen) at the same time as the equity market has become more expensive. 

At the same time, there is now a whole new generation of younger investors who have not experienced anything else than a zero-rate environment. Comparing investment objects with traditional models based on future cash flows has lost its significance, as the central banks especially in the euro area have on non-market terms forced the risk-free rates that constitute the base for the discount rates to become negative. The high prices of risk investments can easily be justified and, correspondingly, their superiority over controls that are even a little less risky can be argued. Perhaps this explains the popularity of the cryptocurrencies and meme stocks as well as the high valuations of some unprofitable companies.
Uncertainty and irrationality tend to increase whenever trends break. On the investment market, this will result in higher and faster price movements, often downwards, at least temporarily.

At the beginning of the coronavirus crisis in 2020, the above-mentioned macroeconomic trends intensified as the tools built during the financial and euro crisis were re-introduced quickly. Both the monetary and fiscal policy was strongly eased while drawing lessons from history, in order to curb the economic crisis. It seemed like the beginning of the end. 

In the second half of 2020 and last year, there has finally been signs of change in the operating environment. 
The economic growth has recovered faster than the trend growth from the lowest levels during the year of the coronavirus, and the inflation has accelerated significantly. In addition to the above-mentioned, society has taken a massive leap forward in the use of various tools that improve work efficiency, both on the demand side and on the supply side. It is therefore likely that this will finally be reflected in Western productivity statistics over the next few years.

The central banks have already gradually begun to tighten their monetary policy. Securities purchase programmes have been reduced and the first interest rate hikes have already quite clearly been communicated to the market. Longer market rates have also started increasing and exceeded the levels prior to the start of the coronavirus crisis, both in the US and in Europe. Admittedly, the levels are still exceptionally low, but the direction of change will be of greater importance in the shorter term. 
Inflation is likely to remain a question mark for several months and cause confusion in the market. The upward trend remains largely related to factors on the supply side due to the coronavirus restrictions, but, of course, the rapid recovery in total demand and rising energy prices also fuel the price pressure.

The relatively moderate movement of market rates in relation to the acceleration of inflation shows that investors see the inflation and the tightening of monetary policy communicated by central banks as a temporary phenomenon. And this is the challenge. As long as the game of cat and mouse continues between market expectations, actual inflation figures and central bank communications, the volatility on the investment market is likely to remain high. This is understandable as the game is linked to the most important trends of the past decade and their continuation. 
It is likely that a new consensus will be found between market participants this year. This may at last mean higher inflation and increasing market rates, but also reasonably good continued economic growth, increased investment demand and productivity growth.
The above-mentioned environment is generally very good from a risk investment point of view, such as the equity market, but the path to a new environment is not straightforward, and it is worth preparing for speed, dangerous situations and higher market volatility on the way. 

Samu Lang

Portfolio Manager