Broad-based financial market growth will become more challenging heading into the next year, but specific investment opportunities do exist, according to investment professionals at the virtual Cayman Captive Forum, who, at the beginning of December, sketched the post-COVID investment environment and looked for sources of return amid major changes in fiscal and monetary policies worldwide.
The post-pandemic investment environment
The current post-pandemic economic recovery landscape continues to be characterised by strong demand causing a massive rebound in activity, but also supply chain bottlenecks, labour shortages and rising prices.
In the financial markets, the low-rate environment persists. US 30-year treasuries still trade below the Federal Reserve’s inflation target of 2%, while equities are running at, or near, all-time highs.
Meanwhile companies, particularly in the United States, have never found it easier to obtain funding. In 2021, companies raised $12.1 trillion by selling stock, issuing debt or arranging new loans. This is almost 17% more than in 2020, the previous record year, and a quarter higher than in 2019, the Financial Times reported, based on data provided by Refinitiv.
Although high-grade bond issuance was down slightly, mainly because many blue chip companies raised so much debt in 2020, junk-rated bond debt soared. After a strong first quarter, special purpose acquisition companies raised more money in the US than IPOs, which also doubled compared to 2020.
At the same time, there is no metric that indicates the crisis induced by the pandemic is in any way comparable to the Great Recession post-2008.
Scott Mildrum, economic and macro strategist at Performa Investment Management, noted that almost all market indicators have recovered much faster this time, from the level of retail sales and job openings to house prices, the stock market or high yield corporate bond spreads.
But inflation remains more than just a transitory issue. The more than 6% annual consumer price growth, in both the US and Cayman, is broad-based and results from a combination of factors, including supply chain issues and energy costs.
Higher input prices, labour shortages and ongoing bottlenecks have pushed the median house price in the US to almost US$410,000.
These higher prices across the board are already hitting consumer confidence, the University of Michigan Consumer Sentiment Survey shows.
Although headline sentiment recovered somewhat in December from the lowest level at any time during the pandemic, one quarter of US households cited the negative impact of inflation on their living standards as the main factor for their personal financial situation.
The small improvement in sentiment in December derived from households in the bottom third income segment expecting to see their incomes rise by 2.8% next year.
High inflation will increase the pressure to raise wages.
Meanwhile, many businesses are already struggling to fill open positions, with job openings at a high, but employees quitting jobs at an unprecedented rate.
To Mildrum, this is a sign that “people feel pretty optimistic about their job prospects” and “are starting to understand that they have some bargaining power” with salary expectations also on the rise.
Monetary and fiscal policy
Since the start of the pandemic, central banks have injected $32 trillion into markets around the world and global equity market capitalisation has soared by $60 trillion.
Now, central banks are indicating a turnaround.
The US Federal Reserve announced that its asset purchases will come to an end in March 2022 and up to three interest rate rises are likely next year.
While some argue that the accommodative policies have continued for too long, the reversal poses a policy risk – the danger that central banks are doing too much too quickly – for investors.
Reece Jarvis, Group Head of Fixed Income at Butterfield Bank in Cayman, said there is certainly going to be disruption as a result of the tapering, the question is: just how much?
Jarvis noted that the Fed’s balance sheet is twice as large as it was in 2018 and equity markets are 60% higher than the last time the US central bank attempted to taper.
Although the Fed has enough flexibility to avoid disruption and unwind in a gradual, measured way, he said, if the highest consumer prices in decades continue, there is a risk that the taper could be dialled up.
Outlook for 2022
Add to that, the potential for disruption from the continuing health crisis and the outlook for next year has to be mixed.
Some large US investment banks, like JP Morgan and Goldman Sachs, believe US equities will continue to rise next year. Morgan Stanley and Bank of America, in contrast, predict a 3% to 5% decline of the S&P 500.
Performa’s Mildrum said, “We do expect growth to continue, albeit at slower rates.”
He said six percent growth rates, that could be seen for several quarters, are unsustainable, but the recovery will ultimately become self-sustaining.
The removal of fiscal support and pressure to raise interest rates will be a headwind to fixed income returns in the short and medium term, he added.
Risk assets, on the other hand, had a much stronger run than anyone could have expected at the start of the pandemic.
Mildrum, therefore, advised captive insurance owners to be selective.
“Make sure you understand where exposures lie and be somewhat defensive when you’re thinking about your risk exposure, given where we are today.”
Nicholas Rilley, investment manager and strategy analyst at Butterfield Bank in Cayman, agreed that “growth next year is obviously going to be a lot weaker than this year” and bond yields remain very low.
He noted that this year’s main story in the equity market has been the strength of corporate earnings which even beat market expectations after they had been revised upwards.
Although equity valuation multiples, like price-earnings ratios, are generally high, they have been coming down simply because in many cases earnings have increased much faster than the stock price, Rilley said.
This is to a large extent rectifying the disconnect seen earlier in the pandemic when equity markets were going up even as economies struggled.
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Disclaimer: this publication does not constitute legal or professional advice and should not be relied on as such.