Two years into the pandemic and trillions printed in new global debt via fiscal and monetary policy, asset prices have recovered from the depths reached in 2020 to great new heights. But where do the markets go from here as we head into a less certain 2022? Which asset classes will benefit the most and how should investors be allocating their funds? As asset allocators meet at the start of Q1, words such as global debt, inflation, stagflation, interest rate hikes are all amongst a few catch phrases that are circling the boardrooms. The key to this dilemma lies in the trajectory of global central bank liquidity, and more importantly the Fed, as we head into 2022.
The U.S. central bank has seen its balance sheet go from $4.5 trillion to now close to $9 trillion in matter of year and a half, the largest such increase seen ever. The problem lies with the Fed unable to ever normalize their balance sheet. Even after the Lehman crisis, the Fed tried to raise rates over the next few years only to cut them again and print even more money every time the system showed signs of crumbling. Each problem required an even bigger response, the only problem now is that debt is so high after Covid induced stimulus, it is mind boggling to think how much QE the Fed would need to do if we get another hiccup in the repo market or economic slowdown.
That will need to be in the trillions per day not months and certainly not years. This eventuality can only mean one thing for the dollar, a near collapse as it is on the road to become a worthless currency at some point. It is clear that the Fed should have cut back on QE earlier this year when economies reopened and cycles normalized, but they choose to keep buying assets even through today! Inflation is not just a phrase, it is a reality. It is averaging about 6%-7% yoy and even though it may come back a bit, we will still be averaging closer to 2%-4% yoy, which is the highest we have seen for decades! Back in 2000 and 2007, the Fed had the luxury of an almost non-existent balance sheet, some room to grow. Today they are faced with a double-edged sword of too high inflation and too much debt. Their hands are tied.
The disinflationary environment of the past decade plus never-ending QE has benefitted large-cap technology stocks, as growth stocks tend to outperform as bond yields fall. This is now reversing, and is one of the reasons why technology will no longer benefit as much into 2022. The Fed is still adding about $90 bln/month of QE hoping to be finished by March 2022. This may provide the market some absolute support, but liquidity is being withdrawn which is key. We still have secular inflation and this is where select commodities will do very well going into 2022, especially the ones that face a tight inventory balance for now.
Copper is one commodity that is in a deficit and will hugely benefit from the transition to clean energy, EV adoption and renewables. China's property slowdown is leaning over the price a bit, but this is no longer a headwind given China is now implementing measures to stabilize the property market post the Evergrande (EGRNF) collapse. Oil is one that is up for debate, and there are some analysts claiming $200/bbl. oil. For now, oil seems to be in a very favorable position going into Q1, as the winter northern hemisphere picks up. If we get a cold snap, there will be a demand surge and OPEC+ supply is still taking its time to come back on the market. But there is no shortage of oil, it is just a matter of timing the seasonal swings. Base Metals like iron ore and steel will not benefit as much as their markets are not in a deficit, whereby government has taken measures to control the rate of emissions and decrease steel output, which lowers demand for iron ore.
It is key to get the demand/supply right when selecting a commodity as it will not be the rising tide lifts all boats scenario. One area of the commodities market that has seen a contentious debate has been precious metals. All the pundits that claimed higher inflation would be good for gold and silver haven't yet had the right thesis, as the price of the commodity has not outperformed this year at all. It is important to consider that precious metals are influenced by macro as well and with a rising dollar and Fed tapering, it tends to offset the positive factors that benefit it. Needless to say, they look very well placed to benefit going into next year as the demand for inflation protected assets should help them finally outperform.
Most investors focus on capital appreciation salivating on 100%+ returns. But sometimes, just sometimes, capital preservation is important as well, especially when global asset classes may fall or be flat at best. Perhaps 2022 will be a true test of what is really a store for value and what was just driven by a surge in liquidity and stimulus.