As we enter the next phase of the market cycles, the key factor for us to consider is a tighter monetary policy regime. We have started to see stocks, especially early-stage technology and new economy companies with no earnings but promises strong growth prospects, falling sharply versus the rest of the market.
There are four scenarios we envisage in how we think about inflation and economic growth in 2022. We would talk about only two scenarios at the extremes. The first scenario would be that high inflation is transitory, and should decline shortly, accompanied with reasonably strong growth. This is a path that the Federal Reserve is attempting to steer towards, and would lead to both bonds and equities to perform well. The second scenario would be inflation staying elevated while growth slows significantly. This scenario would lead to both bonds and equities to face challenging prospects. These two extreme outcomes being debated extensively are the reasons why we are experiencing highly volatile movements in the financial markets to-date.
From our analysis, the base case we envisage is that US policy rates would increase to just around 1.25%-1.50% this year, slightly lower than the US 12-month treasury bills currently. We believe this level of interest rates should not derail the economic growth materially.
The situation is complicated further with an escalation of the Ukraine-Russia crisis with the possibility of commodity price shock, causing inflation to stay stubbornly high, a tail risk we will monitor. If history were to be of any guide, our view is that military confrontations are usually short-lived and a positive outcome would emerge quite quickly.
With such fluid outcomes that could swing from pessimism to optimism within days, we have taken a portfolio stance that should withstand certain levels of volatility from both rising interest rates and geopolitical shocks, while remaining meaningfully invested to capture returns in the meantime. Plainly speaking, we will be more vigorous in risk management and diversification in managing the portfolio.
On the Chinese economic slowdown and property sector issue, we believe the government are in a strong position to absorb the pressure and recover from them. On top of the monetary policy easing from lower lending rates and reserve requirements ratio reduction, the Chinese government is considering lifting some restrictions on developers’ access to cash tied up in escrow accounts, a significant step to ease the property sector’s liquidity crunch. Furthermore, Chinese state-backed funds stepped in to shore up and bargain hunt in the stock market during the month. Foreign investors are investing into Chinese financial markets, believing it is a destination away from inflation and pandemic problems with better growth in the medium term.
The Chinese renminbi is also gaining popularity with its usage internationally. This is significant in many ways as it would provide support for lower valuation premium over US assets and the Chinese economy would also be able to reduce its reliance on the US monetary system especially with several run-ins between US and China over the last few years.