CIO Insights: 2022 Outlook

COVID-19 has accelerated 3 key trends: a new inflation regime, China’s economic recovery, and the Fourth Industrial Revolution.

The pandemic has continued to impact global events in sometimes unpredictable ways this past year. We saw unprecedented stimulus spending in the US, weakened economic growth in China, and now, a new COVID variant creating uncertainty in the markets and our portfolios.

That begs the question, can there possibly be a silver lining to the events of 2021? The short answer is: yes, if you’re focusing on the long term.

Underneath the market noise, we see a few key trends emerging from the pandemic worth keeping an eye on. That's why we thought we'd take a look at these trends and how they're likely to develop and provide new investment opportunities in 2022 and beyond.

We’re entering a new inflation regime

The global response to the pandemic resulted in record-high inflation rates. Here’s how we got here:

• Stimulus measures flushed the economy with cash to encourage more spending
• Supply chain disruptions further pushed up prices
• The US Federal Reserve shifted its stance back in August 2020 to allow inflation levels to run past its usual 2% target to support the economy’s recovery and growth.

Those measures worked well to keep the global economy afloat, but it also resulted in inflation spreading to many consumer goods and services, from food and rent to energy prices.

The Federal Reserve has acknowledged that inflation will persist with us well into 2022, and so will start winding down its pandemic-era stimulus and hiking interest rates.

What’s next for inflation?

The markets are anticipating interest rates to rise next year by 2.5 times the current rate. This rate hike would aim to slow down inflation by making it more expensive for people and companies to borrow and spend money.

But since inflation rates are likely to remain higher than interest rates, we can still expect negative real interest rates. In this scenario, cash value will still depreciate faster with inflation than it can gain from interest rates, such as from a bank savings account. That makes risky assets more attractive to investors, as they're more likely to give higher returns compared to fixed income assets.

We recognise that inflation is likely to stay with us throughout 2022, and that's why our portfolios are balanced with assets that give us inflation protection, including stocks and corporate bonds.

We’ve also been prepared for inflation’s effects since our last reoptimisation. In July 2021, we identified a new economic regime: the US economy was entering inflationary growth, and non-US economies disinflationary growth. Our investment framework, ERAA™, then buffered our portfolios with other inflation-hedging assets, such as US Consumer Staples and Energy, REITs, Emerging Market bonds, and equity allocations to commodity-exporting countries like Australia.

China’s economy is starting to recover

At the end of 2020, western economies were facing the brunt of the pandemic, but it was a different story for China: China was already emerging from the economic effects of the pandemic. That's when China's central bank tightened its monetary policies to keep its economy from overheating. This tightened policy, combined with the country's regulatory crackdowns on its flourishing tech giants, caused China's stocks to fall over the past year.

But China’s economy is starting to recover.

The country's central bank has indicated looser monetary policies: Just this month, it cut the required reserve ratio (RRR) by 0.5 percentage points. Cutting the RRR makes it easier for banks to loan funds, therefore injecting more cash into the economy. (In this case, $188 billion USD).

What’s next for China?

China’s economy will continue to grow. Bloomberg’s poll on economists forecasts that the country’s GDP will grow by 5.3% in 2022, outpacing the growth rate of advanced economies, including the US, Euro Area, and Japan.

Part of this growth is due to the country establishing itself as a tech leader. China aims to reduce its reliance on western countries and become more competitive against low-cost countries with cheap labour.

For example, China plans to supply 70% of its chip demand domestically by 2025, up from about 50% today. And the country’s car boom has only just begun, with smart factories using robots, not humans, to assemble their cars.

Our investment team is keeping an eye on the big picture behind China’s growth, which is why we’re staying invested by maintaining an allocation to China in all of our globally-diversified portfolios.

We’re on the cusp of the Fourth Industrial Revolution

Over the past year, COVID has continued to accelerate technologies all over the world. Many companies have accelerated their digital transformation efforts by as much as 3 to 4 years, with most of these initiatives to stick around for the long term.

For example:

• Companies have rapidly digitised the customer experience with more people shifting to online channels
• The healthcare industry has leveraged artificial intelligence to develop vaccines and perform diagnostic tests
• More companies are using blockchain technology to increase efficiencies and cut costs within their supply chains

If you look at the adoption S-curve, which charts the typical adoption path of technologies, you’ll see that many of these new technologies are on the cusp of future exponential growth.

What’s next for the Fourth Industrial Revolution?

The Third Industrial Revolution used electronics and information technology to automate production. Now, we’re heralding the beginning of the Fourth Industrial Revolution, with technologies that will blur the lines between the physical and virtual worlds.

Our portfolios are ready for 2022

COVID-19 will continue to create uncertainty in financial markets. But it’s also accelerated a number of key trends that aren’t going away any time soon.

Our portfolios are resilient and ready for the new year: they're highly diversified across asset classes and geographies and include allocations to inflation-hedging assets and the China market.

We hope this outlook has encouraged you to maintain a long-term perspective on the key trends shaping not only 2022 but the next decades to come. And finally, we hope you stay safe, stay invested, and have a happy holiday.