Core inflation is expected to fade faster than expected, but energy prices should rise
The outlook for inflation is determined by the supply chain constraints, extreme degrees of liquidity and energy prices. During the pandemic, with many services unavailable, consumers diverted towards manufactured goods. At first, sellers were able to dip into their inventories to meet rising demand before shortages began to pop up across much of the global supply chain. Some production has already rebounded but others will take months as investment is needed to increase capacity.
On the monetary side, both the ECB and Fed are behind the curve, convinced that inflation is mostly a transitory phenomenon and that their credibility is bulletproof. That can lead to a cycle of rising prices leading to wage growth far above productivity, which leads to higher inflation.
It also determines in part the strength of global demand at a time when the supply of goods can’t keep up – in other words the global economy is above the so-called output gap. Inflation in the US has reached levels not seen since the 1990s and the Fed, and to a lesser extent the ECB, are playing a dangerous game, paying little attention to the experience of the past and of many emerging markets. We expect these central banks to steadily and increasingly turn more hawkish as they become more prudent. That should drive a more rapid economic slowdown by the end of 2022.
As inflation abates more rapidly than expected in the second half of 2022, OPEC+ will have a strong incentive to curtail oil production to maximize its rent ahead of a greening economy. As OPEC+ taxes growth as much as it can, the odds are that the market will rapidly accelerate ESG investments and perceive a lower for longer path of growth.
A continued rally
In such an environment, with liquidity moving through the system, decent growth and central banks belatedly moving to control inflation, we should see a continued rally in popular styles such as Growth and Quality, but also the search for Credit and eventually Duration. The realization of lower growth for longer is likely to eventually be a hammer on the Growth and part of the Quality style, especially as companies eventually start to compete on prices to capture market share, encouraged by ever rising regulatory pressures, something we’ll see more likely at year end 2022.
What does it mean?
In an environment where liquidity steadily wins over fears of rising inflation, we are faced with continued trends in North American equities, Growth and the Quality style. But behind this are vast forces steadily shifting as ESG solutions push to the fore and winners and losers are ever more differentiated. That, to us, suggests proper analysis of trends and sectors as well as smart diversification across styles as is available in flexible solutions.
By year end 2022, equity markets should go through the eye of the needle, suggesting holding long-term US Treasuries as a partial hedge. In this phase of strong dispersion, we should see a large amounts of dislocation and, out of these, an enormous opportunity set as some fundamental forces should quickly come to the fore. This includes:
1. Climate change and the broader ESG necessity
2. The renewal of the old economy through new companies and innovations as old sectors find it difficult to adapt and some dominating companies come under strong regulatory pressure
3. High Yield and financials are likely to offer a great but very temporary opportunity to buy as the market will rapidly focus on a world where fixed income is more in demand.
Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches and subsidiaries. This document is advertising material and is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest Key Investor Information Document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management AB recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. A summary of investor rights is available in English through the following link: https://www.nordea.lu/documents/engagement-policy/EP_eng_INT.pdf/. The Legal Entities’ branches and subsidiaries are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and subsidiaries. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and/or subsidiaries.