Good Providence 2022 Outlook

Going into markets of 2022, the biggest channels through which opportunity is likely to present itself – and the biggest risks – will stem from cyclical and ‘secular’ time frames, with large sectors of potential market value at risk of governmental intervention. Conventional economic scenarios traditionally forecast for opportunities and risks being discerned from a confluence of monetary outflows operating at an unsustainable level and credit forming prices that have discounted the odds of an ‘unlikely’ future event that happens to pass. Regarding cyclical time frames, the short- and medium-term implications of the zero-interest-rate paradigm and trans-globally coordinated monetary policies in the developed world being pushed towards their limits have had discounting effects on numerous conventional scenarios. Consumer asset prices and their effect on money and credit market conditions are likely to have revelatory impacts in the short term which provide incentives towards equity investments.

In terms of the global secular environment, for western markets the economic rebalancing between China and the US, the oft-speculated shift away from an Americentric global market paradigm, has continued at an accelerated pace. Key recent differences in political leadership have highlighted aspirational differences for the 21st century between the two states, which can be understood when unpacking virus management programs and accompanying money and credit outflows associated with the packaged policies. Chinese handling of asset and real wealth risks, specifically in the real estate market, have also shown a strong willingness to utilize policies that discount trends isolated from cyclical policies, with asset prices and currencies moving more tightly in line with state targets.

It should be noted that, while this research is about our broader outlook for the year 2022, it is most important to register that an outlook merely provides an ideological framework towards our decision-making. It is the basis of logic utilized to reach conclusions; the merit of individual tenants and views within this framework can be assessed as socio-economic conditions change, which is an inevitable truth regarding markets; implications will change and fall; policies can be mended, discarded, and new ones introduced, but if the logic of decisions is predicated on identifying cause-effect linkages, a paradigm retains value.

The Philosophical Divergences Between East and West, and the Importance of Geographic Diversification in Capital Markets Exposure and the Thucydides Trap

As a broad rule, we identify four primary economic drivers, productivity, long-term debt cycles, short-term debt cycle, and political management.

• Productivity remains the core foundation of any economic system and is the basis of real income, value creation, and wealth over time

• Long-term debt cycles, which impacts the levers, such as investment incentives, policy creation, and the cause-effect linkages at the interplay between forthcoming policy and investment packages, FDI or capital market engagement

• Short-term debt cycles, which are the result of the pulling of economic levers and how the cause-effect linkages play out

• Politics, which shapes who architects policies and shapes market incentives towards investment and productivity

Application of this logic has defined the approximate boundaries of growth in developed economies; at maturation, most developed economies experience coming decades of low productivity growth. It should be noted that this is true when compared to their already high overall productivity. What is more curious in developed economies is that they are, for the most part, in latter stages of their long-term debt cycles, with generally high debt: GDP ratios and a fascination with near-zero interest rates, or negative interest rates in some countries. The convergence of high debts, which limit fiscal options due to servicing costs, and near-floor interest rates stifle spending potential and income growth (through inflationary pressure), which inhibits the ability to solve endemic market issues, but rather, lead to patchwork solutions that constrain future policy options. Narrowed policy options create an exaggerating effect on monetary systems, pressure grows, and debt restructuring becomes the most attractive method through which policymakers choose to relieve market pressures – true monetary solutions require policy latitude, which can only be done through relieving debt burden on state coffers.

Curiously, applying this logic at a few other economies, including some more robust and evolved economies, a very different set of socio-economic conditions emerge – particularly in the East; most importantly China. The determinants of long-term productivity growth forecast that, even in constrained circumstances, China will maintain strong productivity growth, and will be able to leverage the earlier stages of its long-term debt cycle to bolster infrastructure development that is necessary for mid-to late-century forecasts. Other countries with similar conditions are much smaller economies, namely in the Nordic regions (Norway and Finland), are constrained by emergent market sector scope (Korea and Singapore) or are only emerging into a more international presence and are non-developed economies (Ghana, Kenya, Vietnam, and Peru). These countries have leveraged fiscal tools and have more policy flexibility going forward in terms of stimulating growth and managing cyclical economic conditions, however, each has an assortment of social issues that need to be grappled with to maximize this position. Furthermore, it remains to be seen which issues are prioritized and how effectively they manage the required policy levers, especially in the last category as policymakers in those states are comparatively green relative to their peers in the former two groups.

Harvard political scientist Graham Allison also notes another secular issue that interplays with the above, which is a geopolitical conflict between rising and incumbent powers – the Thucydides Trap. These conditions occur regularly through history, and are, for our purposes, marked with increasingly strenuous system pressure, most often leading to war, either in minor trade wars, which can be identified through capital and technology wars – the American pressure on Allies and even non-allied states regarding Huawei technologies come to mind. Conventional warfare is less likely, though hedging towards securitization efforts could translate towards a self-fulfilling prophecy, as history has indicated. Either way, the divergent forces that are the seeding grounds for these tensions will continue to build until either one bends or breaks.

Overabundant QE and an Oversaturation of Liquidity

In examining near-term outlooks for the market in post-pandemic scenarios, one area that looks to require attention is the pathways through which policy responses have passed through the areas of an economy, and the way in which those policy fund allocations have been used. As a rule, an entity’s use of funds/funding must be equal to its sources of funds, in the basic form that sources (‘Money + Credit + Income’) are equal to uses (‘Spending + Financial Asset Purchases + Reserve Allocations’).

In developed economies, measured outflows of quantitative easing have kept spending and credit markets relatively steady through volatile labour markets, the net of which has resulted in an overall equilibrium between produced money and credit relative to lost income, with an overall net surplus of income in relation to spending – reflected in record levels of mortgage buying totals (est. $1.61 trillion in home loans in the USA in 2021). Excess cash not moved into credit or investment has become a net fiscal liability, earning near-zero nominal yields and negative real yields due to historically low-interest rates.

Given this backdrop, cash assets are seeing decade-high levels of devaluation with inflation rates in developed economies as high as they have been, and the importance of a well-diversified portfolio of assets being highlighted with asset prices growing at confidence. What is interesting to observe at the sunset of the pandemic market is if consumer demand ticks upward, or if there persist consumer attitudes away from strong spending habits, especially in highly impacted areas of the economy. The real estate market has already shown strong resilience through the virus and near-zero mortgage rates, a push for work-from-home policies, and decades of stock deficits in high-demand markets have highlighted the value of development opportunities in satellite areas.

However, undercutting all of this is that unsustainable flows of money and credit – which are a key catalyst for opportunity markets – also have unpredictable influences on prices, as these price levels are often discounting future scenarios, especially future money and credit market conditions. Standard pricing is pinned by the simple scenario of x-currency for y-quantity, with prices under this model discounting future economic scenarios if both money and credit markets remain stable (not necessarily fixed). If money and credit markets continue to be produced and grow at relatively stable levels, prices will follow. However, if money and credit markets are inflated or deflated at non-stable levels, such as through several rounds of QE, but not in a unified policy act across lateral states, prices that discount unlikely future economic scenarios begin to fluctuate towards extremes and increase in excess/or shortfall of money and credit markets. Currently, prices reflect the latter scenario, and currency exposure is a significant risk, but real assets present some of the largest opportunities in the near term. Across numerous countries, prior currency declines, equity declines, and climbing interest rate differentials have left discounted future cash outflows quite undervalued and very cheap (ie. unhedged assets) – such as in the Japanese market, the UK market, and the Finnish market where dollars to dollar debt is at near-record amounts, which suggests that low-financed equity investments present promising opportunities.

Tousif Hafiz

Director