At the height of the Covid-19 pandemic in the middle of 2020, policymakers in the most advanced economies were staging their own real-life The Truman Show, reckons Lombard Odier’s chief investment officer Jean-Louis Nakamura.
He is referring to the 1998 psychological comedy-drama, which tells of Truman Burbank (played by actor Jim Carrey), a man adopted by a media corporation and made the unsuspecting star of a long-running reality series The Truman Show, where he lives in a simulated world created by TV executive Christof (played by actor Ed Harris).
Nakamura sees similarities between the movie and real life: Several economies have created a make believe world dominated by boosted household balance sheets, increased private consumption, accelerated job growth and ballooning asset prices.
He says: “Unlike Christof, at least in the US and to a smaller extent Europe are the ones willing to end the programme today, considering the characters at play — consumers, entrepreneurs and investors — are mature enough to understand the necessity to return to the shores of economic reality.”
In the movie, Christof devises an elaborate set of scenarios to dissuade Truman from learning about his false reality. Nakamura compares it to today’s situation, where investors — because they are not sharing the same perception of the economic reality — may try forcing the Federal Reserve (Fed) not to “drop the set”. This could possibly be done though a storming sell-off in markets, he reasons.
The questions to ask this year: How will the global economy react to the significant withdrawal of policy support? How far apart are the perceptions between investors and central banks about the long-term economic “realities” and who is likely to be right?
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This year may have started off with macroeconomic data, policymakers’ stance and potential public health developments sending mixed signals about the possible market dynamics over the next few months, but for now, the momentum in global economic conditions still appears robust, says Lombard Odier.
Robust economic conditions
With the latest Covid-19 Omicron variant now making waves across the globe, Nakamura believes that this visibility may be further blurred as to who is right or wrong in this debate. He adds that 2022 should remain supportive for equities but with returns discounted by downward revisions in earnings growth and weaker risk appetite.
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Meanwhile, things are not looking up for bonds as the Fed accelerates its tightening. Still, Nakamura expects lower yields to emerge as a likely outcome by the end of this year. And as China stabilises its own domestic situation, Asian credit may celebrate a comeback later this year.
On commodities, Nakamura believes that energy prices will remain a major source of risk in the first few months of 2022, but this should recede as demand decelerates. “Do not chase the rally on energy and industrial commodities,” warns Nakamura, adding that cyclical commodities may have passed their peak. He also believes that agricultural prices may continue to enjoy a positive momentum for the first half of 2022, while precious metals currently lack support.
“Volatility is still cheap, but accumulating too much protection might prove costly,” he adds. The rationale to accumulate some tail-hedge protection is still here, but the last decade has demonstrated extreme corrections should remain temporary.
Stocks to watch out for
Investors who are able to take on high levels of noise and volatility over the next few months should look out for secular-themed stocks, especially stocks that have a strong sustainability model, have asset-light business models, are high quality brands and have a large capitalisation. For the more cautious investor, Nakamura suggests to seek refuge in diversification — including in long-duration bonds — while cautiously accumulating equities from economies likely to reflate and de-correlate this year, such as China and Japan, at the expense of the ones tightening their financial conditions, like the US.
But there are still risks as Covid-19 continues. “We continue to argue that the main risk for markets remains a confusion between the economic imbalances induced by the pandemic, likely to persist for longer but with incrementally smaller impact, and a structural regime shift in terms of growth and inflation,” says Nakamura.
Photo: Albert Chua/ The Edge Singapore
