Investors should brace for limited gains in 2022

Can the bull markets continue in 2022? We’ve had a great run in the US on the back of billions of newly-minted electronic dollars and large fiscal boosts. The S&P 500 index rose by about 30 per cent in 2021. Monetary expansion will now be tapered.

European and some Asian markets have tried to keep up and have risen in response to economic recovery, only to run into Covid-19 troubles again. China performed badly as it continued its move to a more Marxist approach, attacking entrepreneurs and property owners in an anti-free enterprise stance with Chinese characteristics. The Hang Seng Hong Kong Index was down 15 per cent over 2021.

The fund delivered a return of 7.75 per cent for the year on its risk-controlled mix of bonds and shares. Equity investments benefited from the accent on the US and world recovery. The specialist world indices capturing the green themes performed only moderately well after their spectacular 2020. The position was reduced and some profits taken.

The investment in global indices in the digital sector mainly gave decent returns but underperformed the tech-focused Nasdaq’s larger stocks. The bond portfolio was in a mixture of index-linked government securities and cash. This protected it from the forecasts of rising inflation and the beginnings of interest rate rises around the globe which depressed many conventional bonds.

2022 is having a difficult birth. The pall of Covid hangs over us still. So far Omicron has proved a less lethal variant, though it has spread fast. We expect the world to get used to living with the virus next year as vaccines, better treatments and a build-up of immunities abates its more dangerous powers. The year should see some progressive relaxation of the current restrictions in many places.

The inflationary consequences of the last two years of binge borrowing and printing by governments and central banks is catching up with us, and has further to go before reaching a peak next spring.

Joe Biden, the US president, is struggling against low poll ratings and finding it difficult to get his flagship spending and tax measures through his own party in the Senate. The new German government endorses enthusiastically the EU’s wish to travel faster to net zero, with adverse consequences for traditional EU carmakers, electricity generators, fossil fuel producers and the rest. Many central banks will gently raise interest rates as they shift nervously away from earlier confident predictions that inflation would prove limited and shortlived. Money printing will end in the US and UK and proceed more cautiously in the eurozone.

This year is likely to see continuing Cold War-type tensions between the US and its allies on one hand and Russia and China, the west’s disrupters, on the other

The advanced world is having to adjust to the new China, one that is more autocratic and nationalistic, as she asserts herself more and expands her ambit of influence through Asia and the Middle East.

This year is likely to see continuing Cold War-type tensions between the US and its allies on the one hand and Russia and China, the west’s disrupters, on the other.

Energy price rises have in part been brought on by Russia’s manipulation of gas supply for Europe, while European supply chains have had some problems with goods deliveries from China.

Meanwhile our two longstanding themes of the digital and the green revolutions will continue to occupy much investment time. In Europe, 2022 will open with governments struggling to combat the surge in energy prices, which will damage real incomes and output. Periods of little wind and accelerated closures of older fossil fuel and nuclear power stations make life more difficult. Gas will be used more as a transition fuel to cushion the impact a bit.

I assume for the portfolio that Russia will provoke the west but will not mount a frontal invasion of Ukraine with the risk of war with Nato troops.

I assume China will continue to consolidate control over Hong Kong, its western provinces and Tibet, but will not launch an invasion of Taiwan, recognising that the US still offers plenty of support to the island. There may well be further cyber attacks along with official denials of state involvement.

There could be infiltrations of Russian troops to help forces friendly to them in countries as near to the UK as Ukraine and Belarus.

There will be a clear refusal to follow western standards in the pursuit of net zero or corporate governance or human rights by China, Russia and various emerging market countries. Investors who are taking a stronger interest in the environmental, governance and social issues around their investments will have to think through how this can be combined with investment in the Chinese and Russian spheres of economic activity.

I took the FT fund out of Chinese ETFs in 2020, seeing the authoritarian tendencies growing in Beijing. The switch into Taiwan with its democratic system has so far worked well as an investment idea with much better performance.

The world will split over the net zero climate target. India and other leading emerging countries will align with China in declining to cut their emissions any time soon, on the grounds that they need cheaper fossil fuels and their reliable technologies to speed their growth.

Within the western grouping there may be more tensions over how seriously countries take net zero. Richer European countries will be the leading force to speed transition. The US under Biden will give plenty of rhetorical support, but will still rely more on fossil energy from its own resources to steal a competitive march. The president has been issuing new permits to explore and drill for oil and gas.

Most of the rest of the world will pay homage to the concept of net zero, delay its implementation and demand more concessions from the west to help. China will continue to specialise in supplying green products to the west, made by its fossil-fuel dependent industries, while expanding its own extensive use of coal.

This will make 2022 a more difficult year for investors. With less monetary and fiscal support, high initial valuations and with many uncertainties over policy, the virus and the disruption to come from China and Russia, my base case assumes low positive returns for the year from the current portfolio.

I will be watching out for too much inflation, too much policy tightening or too much international tension as any of these could flip us into a bear market. If one of these bad scenarios emerged, it would be necessary to further reduce risks in the portfolio by holding more in cash and low-risk bonds to the extent allowed by the fund rules.

More trouble from the virus would probably delay a tough policy response that would damage markets. This would also favour digital businesses over companies dependent on social contact, both in work and leisure time, and so support digitally-driven groups. Recovery investments in areas like travel, hospitality and other personal services will need better news on the virus.

Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. john.redwood@ft.com