What could be the key issues next year?
1. We are likely to discover that after the current bout of inflation, core inflation falls back relatively quickly in the United States and Europe, less so in the UK. This should slow the pace of Fed and ECB tapering and delay expectations of a lift off in interest rates, thus supporting equities. The European bond market expects this, the US fixed income market far less so with persistent and elevated break-even inflation.
The reasons for this eventually quickly-fading inflation are: 1. Automation 2. Outsourcing 3. Pressure from equity owners to keep costs under control 4. Weak worker bargaining-power in an economy that is increasingly oligopolistic. 5. Disappearance of unions outside of Germany. 6. The self-reinforcing expectations of low inflation expectations in corporate pricing strategies leading to cut other costs especially from suppliers often in China. 7. Long-term pressures such as ageing and productivity 8. Moderate bargaining power of renters somewhat delaying inflation.
2. Over time the pandemic should be ever better managed especially in emerging markets as old and new vaccines are deployed including to children and more coercive measures are deployed. The danger is the unknown emergence of a more dangerous Covid-19 variant. Much of this is consensus.
3. A fiscal impulse will probably come from the US and again from the European Union to boost growth, while the confrontation with China peaks for the US midterm elections.
4. A correction of risky assets potentially led by real estate and High Yield is likely in H2 2022 as excessive momentum and valuations meets much weaker growth expectations for the next few years.
What could be the key issues for 2023-2025?
1. A big slow-down of the World economy as governments find it harder to finance larger fiscal spending and ageing kicks in. While Vietnam’s growth might still trend at a decent pace, China hobbled by debt, excessive investments, ageing and the transition to services should slow down substantially and may be tempted to weaken its currency to support its manufacturing and compensate for carbon border import taxes. That could lead to waves of competitive devaluations within Asia Pacific and Emerging Markets.
2. Acceleration of ESG concerns on the back of the cost of climate change leading to increases in inflation. Fights around carbon taxes should fundamentally re-shape the global supply chains making them more expensive and inefficient. All of this is likely to translate into a higher level of inflation, all things being equal.
3. Structural reforms such as digitalization in the US and European economy should start paying off and accelerate. This should also destabilize workers used to greater certainty in their prospects, affecting demand.
Conclusion
What we are faced with as ever is a wall of worries which should peak in H2 2022 on excessive momentum in equity markets. But behind this are secular forces steadily emerging, namely a new economy within a new climate and ESG paradigm. Significant setbacks in the Growth style are opportunities to invest selectively in this emergent paradigm of ESG.
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