2021 was full of contradictions, so what will 2022 bring?
“Despite inflation, bond yields haven’t gone up, which is weird”
John Stepek: What surprised you most and what surprised you least in what’s been a very weird year?
Simon Edelsten: I totally agree it’s been “weird”. The main thing that everyone had feared would happen – inflation – happened. But according to the economics textbooks, bond yields were supposed to go up, and they haven’t. That confuses everyone. It causes issues for savers and I think it should cause some caution for us. It wouldn’t take much of a move in bond yields towards the inflation we’ve already seen for markets to struggle quite a bit. And yet everyone seems to be dead bullish. Global equities are up 20% this year and they went up even more than that the year before, from the lows. So the equity market is behaving as if it’s party time.
Max King: I agree that the big surprise has been that despite inflation bond yields haven’t gone up – and if they haven’t gone up now, it’s very unlikely that they’re going to. It seems to me that the world is populated by Christmas Grinches who spend all their time trying to convince people that the market is about to crash. We are in a golden age of property and stockmarket investment, and despite grumbles about valuations, I don’t see markets as particularly expensive in most of the world. So “don’t worry, be happy” is my message.
Steve Russell: I think I have to come in there and do my best to be a Christmas Grinch. We’ve been predicting inflation for ages, but when it actually came along and stayed, we were surprised – we didn’t expect US inflation to now be nearly 7%. But we did absolutely expect bond yields and interest rates to stay nailed to the floor. The problem is that markets have decided that real interest rates are the discount rate, and this is just wrong. Say interest rates remain at 0% and inflation is at 10% – you’ve got a minus 10% real rate. But you still have to discount future cash flows by 10% inflation to get the current valuation [when the discount rate rises, current valuations should fall, all else being equal]. So I think markets face a painful re-rating that will kill the bull market, once there’s a realisation that inflation is persistent, but that central banks aren’t raising rates and that bond yields are just a false market.
Until that happens – next year, maybe the year after? – equities will be attractive because we’re getting
