the joys of uncertainty6 Dec 2021 11:18
in 2021, the global macroeconomic environment changed, but the investment environment did not. This parting of the ways (posted on this previously) has two possible explanations:
Option #1: Markets have not responded to the surge in inflation because it is transitory in nature. Soon, inflation will roll over and the macro environment will return to what prevailed for most of the past decade; namely, low growth and low inflation. In short, the market is looking through today’s “inflation head fake”.
Option #2: For financial markets, the macro environment matters to the extent that fiscal or monetary policies are impacted. And, as it turns out, although inflation did accelerate in 2021, the policy setting in most OECD countries stayed the same: fiscal policies remained stimulative and were funded by extremely expansionary monetary policies. Hence markets were able to brush off any changes in the broader macro environment.
With the “transitory” nature of inflation getting extended, it seems to many at least that the second explanation is the most persuasive. Hence, the next question is whether 2022 delivers more of the same from Western policymakers, and thus a further divergence between the macro environment and the investment environment.
The next question is: will policymakers want to, at least, be seen trying to put the inflation genie back in its bottle? Looking ahead to 2022, three possible scenarios stand out as possible:
Scenario #1. Inflation rolls over, resulting in a synchronization of the macro environment and the investment environment. Given the continued rise in energy prices and rents, this outcome, for now, seems unlikely. Still, in such a scenario, bonds should do well and US growth stocks would continue to scale new heights.
Scenario #2. Inflation stays high and Western policymakers move against inflation with a sharp tightening of both monetary and fiscal policies. Such a scenario would likely trigger sell-offs in most asset classes, but especially in more richly-valued market segments.
Scenario #3. Inflation remains high, but fiscal and monetary policies are kept loose. In such an environment, bonds would likely prove to be very poor investments. Value stocks would probably outperform growth plays and emerging markets (where fiscal and monetary policies are already being tightened) would likely outperform US equities.
Of these three options, the latter seems to have the highest odds. The Fed may plan to speed up its asset purchase taper but it is likely to remain behind the curve in its overall settings. Moreover, the emergence of the omicron Covid variant is only likely to reinforce the willingness of Western central banks to ultimately sit on their hands, and goodness only knows what the pollies will do?
the joys of uncertainty
the gnome
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