As Bill Gross amply demonstrated, it’s unwise to try to predict the future, but it is prudent to consider the balance of probabilities. Right now, aside from the pandemic, inflation appears to be the big risk in the global economy. Even if it proves to be transitory, a bout of inflation is still extremely negative for the fixed income streams provided by bonds. If inflation persists, it’s even worse. Particularly if that is accompanied by central banks closing their massive bond purchasing programmes. There is of course a chance that the global economic recovery will stutter, that inflation will fall away, and central banks will ease back on tightening policy. The Omicron variant has shown this isn’t just a theoretical hypothesis. In that scenario, bonds would rally again. But even then, it’s a stay of execution rather than a pardon. Unless we believe that monetary policy will never normalise, and that QE is here forever, there must come a day of reckoning for the bond market. It might be a gradual deflation rather than an explosive rupture, but it does look like a question of when, not if. Long dated government bonds would be most in the firing line so bond investors could seek to protect themselves by looking to shorter dated bonds, higher yielding markets, and strategic funds that employ a flexible approach.
Cash
Interest rates will almost certainly rise again in 2022, but this will be a pyrrhic victory for cash savers, because inflation will rise faster. As a result, money in the bank will be losing its buying power even faster. Inflation is forecast to hit 6% in spring, but is then expected to moderate over the next three years. For much of that time, CPI will still be above the 2% target though. Cash therefore still looks like an uncomfortable place to be for the foreseeable. It’s still the only option for short term savings that might be needed at the drop of the hat, but as a longer term store of value, the return of inflation has left cash looking even more woeful. Savers should aim to have three to six months’ worth of expenses set aside in cash for an emergency, but should consider investing anything above that which they are willing to leave untouched for five to ten years or more. Investing any cash gradually will help to level out entry points into the market, and make for a smoother journey.
UK Property
Residential property – It’s hard to get a proper read on the UK housing market, given the huge distortions created by low interest rates, long term government subsidies, short term government booster shots, and the pandemic. One thing seems certain- the next year won’t be anywhere near as good for house prices as the last twelve months, which were turbo charged by the stamp duty holiday, changing working patterns and ultra low mortgage rates. While growth will moderate, it might not disappear altogether though, given the imbalance between housing supply and demand in the UK. Higher interest rates will be a slight headwind for the property market, but many households have bought a big bit of protection by fixing, and by the time they have to remortgage, higher wages will probably have taken up a lot of the slack. In recent years around 95% of new mortgages have been on fixed rates, up from about 60% ten years ago, according to UK Finance. Anyone hoping for a house price crash to finally jump on the ladder may be sorely disappointed.
Commercial property – the sector may have recovered from the depths of the pandemic, but there’s still a great deal of uncertainty over its prospects as we head into 2022. Widescale hybrid working is still in its infancy, and it remains to be seen to what extent office space is desirable for UK plc. Where it is in demand, big corporations will likely place a premium on sustainably built spaces that enable them to lower their carbon footprint. Low unemployment and economic growth should help to underpin office and retail space, and the continued growth of ecommerce after the quantum leap of the pandemic should mean more demand for logistical hubs. Inflation and the potential for interest rate rises will take some of the shine off commercial property yields, which could prompt some investors to move elsewhere, particularly if there is a material rise in bond yields. For open-ended fund investors the FCA’s long-awaited policy on notice periods still hangs over the sector like the sword of Damocles. If the regulator does impose long notice periods on open-ended commercial property funds, that’s likely to at least dent demand, and in the worst case scenario could lead to a synchronised exodus, dealing suspensions, and fund closures.
Gold
The resurgence of inflation has put some pep in the step of goldbugs, though the precious metal has really failed to shine since the early days of the pandemic, when it topped $2,000 an ounce. Part of the problem may be that interest rates are also expected to rise, and as gold pays no income, it looks less attractive by comparison with interest bearing assets like bonds and cash. That dynamic can be expected to deepen in 2022, if central banks tighten policy as expected. The lack of any cash flows also makes the precious metal difficult to value and volatile – there’s a reason Bitcoin is called digital gold. Gold is known as a safe haven, but between 2011 and 2015 investors had to stomach a 40% fall, so it’s not an asset for the feint-hearted. It works best as a small bit of insurance that acts a bit differently to other assets, so it should only make up 5 to 10% of a portfolio at most.
