INFLATION will remain a major theme for investors heading into 2022.
According to Amundi, inflation will not likely return to pre-crisis levels as supply chain bottlenecks, surging energy prices, the rebalancing towards higher wages and rising tax rates will push it higher compared to the past decade.
The European asset manager notes what initially has been a United States story has already spread globally through rising food and energy prices. It reckons central banks will stay vigilant in managing the trade-off between growth and inflation.
Amundi is convinced this will be the dominant market narrative throughout 2022 and will further increase the asynchrony of monetary policies across the globe.
Besides inflation, Amundi has also identified de-synchronisation in relation to China, fiscal and monetary policies; and an acceleration of ESG (environmental, social and governance) integration into portfolios as the other two major themes that will drive investors next year.
In conjunction with the recent launch of the group’s investment outlook for 2022, Amundi chief investment officer Pascal Blanqué notes that a new financial regime has started, characterised by 1970s-style stagflationary features.
“The end of the ultra-easy monetary era, as well as the growing momentum for policies targeting the green and just transformation, will define new mandates for central banks,” he says.
“Their reaction function appears uncertain and inflation expectations may become unanchored. Expect some reordering of risk premia, when real and nominal yields start rising, and ESG factors having an increasing impact on market prices,” he adds.
The key elements to consider in portfolio construction will be return, liquidity risk and exposure to growth and inflation, Amundi reckons. With the emergence of a new market regime as the world emerges from the Covid-19 pandemic, it says, investors will likely face more challenges in the year ahead compared to 2021 in terms of portfolio construction.
For one thing, investors cannot expect 2021-level returns for equities, amid an environment of normalising earnings growth and mounting pressure on margins.
For another, pressure on government bonds will likely continue while interest rates will start to rise. With real yields globally in the low range, the search for real income will continue, Amundi explains.
On that note, the asset manager recommends investors to “start light or neutral” in terms of risk exposure and recalibrate risk throughout the year, with a focus on portfolio resilience to rising yields.
“Investors should start the year with a cautious or neutral allocation (also considering stretched market valuations) and try to exploit relative value opportunities (across regions and segments).
“In a sequence of slowing growth followed by more stimulus, investors will likely have a window to increase risk allocation again and exploit the opportunities brought by an extended cycle (such as equities, selective emerging market or EM and commodities).
“Risk and liquidity management will be key as rising real yields may bring some market turbulence and challenges for both equity and bonds simultaneously,” it explains.
The 60:40 portfolio will be challenged by potentially positive equity-bond correlation and this calls for more dynamic allocation, Amundi stresses, noting relative value plays and additional sources of diversification that can potentially mitigate inflation risk, such as real assets, will be key.
In an environment of structurally higher inflation, investors could search for real income by enlarging the asset class spectrum.
This will mean going beyond the traditional bond space and looking at equity dividends; real assets; EM bonds, with a focus on short duration; and more generally at areas offering higher yields, with relatively low duration risk such as subordinated credit and loans, Amundi suggests.
“Credit with longer duration and/or where spreads are too tight will be challenged. Overall credit selection will be in focus as defaults may start to rise from low levels, with the rising cost of debt,” it argues.
On equities, Amundi recommends the least stretched areas (such as value, EM and Europe) and sensitivity to higher rates.
“Earnings growth will decelerate from the record levels seen in 2021, but some businesses are likely to continue to benefit from the ongoing reopening while others will suffer from rising costs, taxation and supply chain readjustments,” it says.
“This will lead to an environment of high dispersion of returns among stocks providing a positive backdrop for stock picking. Interest rates will remain reasonably low but on a rising trajectory, favouring equity value (particularly financials) versus growth,” it adds.
EM equities in play
The asset manager expects EM equities to be back in focus in 2022.
“Equity exposure has increased to a peak in the cycle, favouring developed-market equities. The next increase should favour EM, where allocations are far below the strategic target and valuations look relatively attractive,” it explains.
When looking at EM opportunities, Amundi points out, a country-by-country assessment is essential in the context of China’s policies, price evolution and fiscal and monetary room.
As for European equities, Amundi says, the market will be favoured thanks to the region’s next-generation regime that places great emphasis on “green transition”.
Meanwhile, it also recommends that investors add thematic exposure to ESG factors that will likely have a material impact on risk-returns.
“ESG themes should be seen as complementary to the classical portfolio metrics of risk and return, particularly when it comes to areas that could have a material impact on asset prices,” it says.
“Changes to regulations and rising demand from institutions and investors are ensuring some factors are becoming increasingly relevant in this respect,” it explains.