Protect your portfolio for an uncertain 2022
Inflation and the Omicron variant are forcing us to be more cautious. For many, equities still remain the favoured asset class, but the ideal portfolio for 2022 shows more defensive accents. We are building in a little more caution in our clients' portfolios. Much has to do with the covid crisis, which seems less under control than it was six months ago.
Due to the outbreak of the Omicron variant, we are taking a more cautious stance. Vigilance seems warranted, as the outbreak is a great unknown, adding to the uncertainty. In addition to the health crisis, rising inflation is also worrying, we even call it the investment theme of 2022. Inflation will remain in the spotlight for a while as we predict inflation peaks in the first quarter and then slowly declines. There is also a risk that higher inflation will be less temporary than expected.
Central banks will react too strongly to inflation next year: a sharper than expected monetary policy tightening could push us into a slowdown in growth towards the end of 2022, resulting in a flatter yield curve. In light of all these uncertainties, we agree that 2022 could be a very volatile year for the stock market, the many uncertainties will translate into quite a few price fluctuations. Both bond yields and equity markets will eventually end higher, but compared to other years, the probability that we link to a base case is a lot smaller. In other words, the chance of a completely different scenario is greater than normal. Against that background, it makes sense to build a little more security into our clients' portfolios.
Below we list a few defensive accents for the stock market.
1. Selective stock
If inflation remains an important theme in 2022, our clients can best protect themselves against it with equities. Equities will remain the preferred asset class in the medium term, they will be the most successful in passing on the higher inflation, so that profitability will not really come under pressure. That will have positive consequences for share prices. Yet selectivity is crucial, the emphasis should be on quality. You should opt for shares of companies with a very strong competitive position because they can calculate inflation more easily, stocks of quality companies offer a good view of future earnings and they have pricing power.
2. Careful with emerging markets
Also regionally, we opt for less risk. Six months ago, emerging markets were still a favourite region for equities, today that is no longer the case. We opt for Europe and refer to the interest rate sensitivity of the emerging markets. Europe is relatively attractive in valuation and the chance of interest rate hikes is smaller than in other regions. That is why our choice does not fall on the emerging markets. They are attractive in terms of valuation and have clearly lagged behind this year, but on average they are also a lot more sensitive to interest rate hikes. The vaccination rate is also a lot lower in this region, which can weigh on growth. We are also concerned about the economic momentum in China. We are not just talking about the real estate sector, but also about the tighter ideological stance. Moreover, the surge in inflation and possible capital flight is already prompting many of the emerging countries to tighten their monetary policy. As a result, we expect the growth differential between emerging countries and industrialised economies to be at its lowest level in 2022. Chinese growth will be the guiding principle. We are seeing a bottoming out, but the strength of the Chinese growth acceleration is very uncertain, partly due to pressure in the real estate sector.
3. Watch out for growth stocks
Technology is still one of our favoured sectors, but is down one place in the ranking compared to six months ago. Growth stocks, such as those of the technology companies, will suffer more from the gradual rise in interest rates. We recommend caution with those sectors of the stock market where we have seen hype this year. 2022 may be a year where profitable companies with solid balance sheets will once again make the most of the overhyped, overvalued and often loss-making meme stocks. We put the banking sector forward as a favourite for 2022. Financial stocks will be the first to benefit from the gradual rise in long-term interest rates. Moreover, the valuations are reasonable and European banks in particular will benefit from a slightly steeper yield curve. Finally, there is also the (defensive) pharmaceutical sector. We see opportunities here mainly through innovation. In the past, the healthcare sector often lagged behind other sectors when it came to integrating technological tools. In the coming months and years, we see investment opportunities in companies that enable the technological transformation of healthcare. Think of IT service providers, data suppliers and manufacturers of medical equipment.
4. Protect your bond portfolio
We also making adjustments in the bond portfolio, In particular, bond investors should keep the interest rate sensitivity (duration) of their portfolio under control, so that the potential loss does not rise too high with rising interest rates. Low-duration bonds see their prices fall less when interest rates rise. We also advocate shorter maturities as we opt for an average duration of four to five years. We also opt for inflation-linked bonds as we invest to a large extent in lefties, because they form a protection if inflation - against our expectations - should start to derail.
5. Alternatives like diversification
Not everyone is in favour of it, but we are still pushing alternative investments as a way to diversify our clients' portfolios. When inflation sets in, it can help to invest in real assets such as real estate. Investors looking to protect themselves against unexpectedly high inflation can look to real assets such as real estate, land and infrastructure. Commodities also seem obvious in a climate of rising prices, raw materials deserve a limited place in everyone's portfolio. We have in our own portfolio a mix of gold and CO₂ allowances, gold acts as a diversifier and protects against a stagflation scenario. This precious metal can also be a refuge if investor optimism wanes a bit. CO₂ emission rights are a new sub-asset class, they are a crucial factor in the European Union's climate policy and are used to stimulate the transition from fossil fuels to alternative energy sources. We expect that there will be an imbalance between supply and demand for these emission allowances in the coming years and this would further increase the price. Yet there are also warnings about investing in commodities: oil and gas can still receive support if it turns into a cold winter, but the balance between supply and demand seems to be recovering.
In summary, we are more cautious than usual for the new year. In 2022, we will work with our clients on the 'new normal', which will only take shape in due course.
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