Top Nine Investing Trends to Watch in 2022, Part 7 – The Influential Me’s

Today we continue with our top trends for 2022 as part of our ongoing series, “Our Top Nine Investing Trends to Watch in 2022”

In this series, we’ll cover our top 9 investment ideas:

1. The Great Lithium Disconnect
2. Decarbonization — green switch on
3. The future of payments
4. Quantum Computing and Moore’s Law on Steroids
5. Connected devices and memory
6. Decentralized finance—an “Amazon in 1994” moment
7. Influential “I’s”
8. Watch out for gold
9. Equities – Watch out for high valuations

If you want to download all 9 trends in one document to read at your leisure, just enter your email below and have it delivered straight to your inbox.

Trend #7 — Influential Is

2022 should be dominated by two influential Is: inflation and interest rates.

Inflation

After an enforced absence, inflation is back.

As the the wall street journal reported end of 2021:

Inflation hit a nearly four-decade high in November. Figures from the US Department of Labor showed the consumer price index – which measures what people pay for goods and services – rose 6.8% in November from a year ago. Pricing pressures were driven by strong demand and pandemic-related supply chain issues, as well as rising energy prices.

Source: United States Bureau of Labor Statistics

Australian inflation is less pronounced, but still high.

inflation in Australia since 1996

Source: Reserve Bank of Australia

Inflation is rising just as rapidly almost everywhere else.

Central banks in emerging markets like Brazil, Chile, Colombia, Mexico and Russia, for example, are already raising policy rates in response.

Advanced economies such as England, Norway, Korea and New Zealand also increased their rates.

As the business information firm S&P Global pointed out:

persistently high inflation requiring unforeseen policy adjustment is now the main macro risk for 2022.’

S&P Global’s position was echoed by none other than US Federal Reserve Chairman Jerome Powell, who said on December 1, 2021 that “the risks of higher inflation have increased” and ‘we will use our tools to ensure that this high inflation that we are experiencing does not take root‘.

Investors take rising inflation seriously.

According to figures from the Australian Financial ReviewInvestors poured a record US$70 billion into US inflation-protected bond funds in 2021 in a global rush to hedge against rising consumer prices.

2021 inflows into inflation-protected securities in 2021 were greater than any year followed by EPFR — going back to 2004.

Our previously discussed trend to watch in 2022, decarbonization, also makes matters worse.

While noble in its foresight, decarbonization is straining global supply chains in the short term, impacting inflation.

Asset manager giant BlackRock noted in a 2021 research note:

We view the transition to net zero as a supply shock that unfolds over decades, helping to reinforce ever-higher inflation.

A disorderly transition – where policy measures to reduce emissions are imposed suddenly – could lead to energy shortages and mismatches between companies and sectors.

In our view, a smooth transition is even more important for the path of inflation than monetary policy.

The The energy crisis of late 2021 hinted at a messy transition.

When weather and geopolitical factors suddenly cut coal and renewable energy supplies, other energy sources struggled to make up for the drop. As governments seek to minimize carbon emissions, natural gas prices have risen even more than coal, as the chart shows.’

Chart of commodity prices since 2017Source: BlackRock

Interest rate

With rising inflation, the market will be nervously watching what central banks decide to do with interest rates.

The US Federal Reserve, for example, set the stage for a series of interest rate hikes from 2022. A pivot that showed heightened concern about the persistence of inflation.

As the the wall street journal reported in late 2021, most Fed central bank officials now expect at least three quarter-percentage-point rate hikes in 2022.

In September 2021, about half of these officials believed that rate increases would not be warranted until 2023.

Additionally, Bloomberg reported in 2021 that:

Swaps already suggest the central bank’s target will be 88 basis points higher by the end of this year – seen by many as a sign that the market is cooking in three bulls, plus the possibility of a fourth in 2022 – and the momentum is building for the first increase to take place as early as March.

And in December 2021, Morgan Stanley’s economics team released a note estimating that US interest rates should rise as early as September 2022.

Morgan Stanley thinks September’s rise will be the first of five over the next two years.

Morgan Stanley wrote:

We now expect the FOMC to start raising interest rates in September next year, two quarters ahead of schedule. After delivering two rate hikes in 2022 (in September and December), we expect three hikes in 2023.’

As for Australia, ANZ expects the RBA to announce the first hike in the first half of 2023, Westpac expects the first hike in February 2023 and NAB expects one in mid-2023.

The Commonwealth Bank and AMP Capital, however, foresee an earlier rise, in November 2022.

Why is this important for the markets? What effect do interest rate hikes have?

Illustrative information may be obtained from the market information company S&P Global.

In December 2021, S&P Global ran some tests to examine how the world would cope with a 3% increase in interest rates and high production costs.

As the market intelligence agency reported:

Our stress scenario for a 300 basis point interest rate hike only assumes that rates would return to pre-global financial crisis levels. However, we find that this increase significantly modify the financial statements of the issuing companies. Entities with weak credit indicators may find it difficult to access credit markets.

S&P Global’s test sample included 24,000 companies, covering $61 billion in corporate debt. What was the main discovery?

Higher debt servicing costs coupled with higher input costs implied by rising inflation will shift more than $1 trillion of debt onto the balance sheets of loss-making companies.

The share of debt owed by loss-making companies is is already operating at double the average of the last decade, at 7%. Thus, a 3 percentage point increase in borrowing costs would raise this ratio to 10%, while the double shock of the increase in interest rates and the cost of inputs would raise the ratio to 12%.

Theory of inflation on the example of the company

Source: Australian Financial Review

But a rise in interest rates will also have an impact on households.

A uniform exercise of a 300 basis point interest rate shock would return households to the debt service positions they held in 2008 [during the global financial crisis].

Affected households have reduced discretionary spending…a lifeblood for many businesses.

Consumer spending is one of the most important determinants of demand. For example, consumer spending accounts for almost 70% of US GDP.

As for the stock market, rising interest rates often put pressure on high-flying concept or growth stocks that have yet to reach profitability.

As Princeton University economist Burton Malkiel once pointed out:

Since stock yields must rise or fall to be competitive with bond yields, there is a tendency when interest rates rise so that bond and stock prices fall, and interest rates fall so that bond and stock prices rise.

Of course, interest rates around the world are at historic lows, so any increases in 2022 will come from a low base, altering any effect on equity markets.

But investment bank JPMorgan, featured in Bloomberg’s compilation of 500+ investment insights for 2022, warned:

Rising interest rates and slightly tighter monetary policy should be a headwind for high-multiple markets such as the Nasdaq.’

A little about us — Fat Tail Investment Research

While themes and trends may come and go, one thing that never goes out of fashion in the investment world is insightful analysis.

Information is the crucial ingredient of markets.

But information alone is not enough.

It’s the rational analysis of information that separates a healthy idea from a weak idea.

At Fat Tail, our editors pride themselves on providing valuable insight by applying their industry experience and knowledge.

At Fat Tail, we value differences.

Disagreement is not censored but encouraged.

And we find that our readers appreciate the range of thoughts and ideas of our editors.

At Fat Tail, we have bulls, we have bears, we have crypto advocates and gold bugs.

At the heart of it, however, we have a team dedicated to the free exchange of ideas. Reason trumps agenda here.