2022 Outlook Q&A: Crypto, Inflation and Energy Transition
21 December 2021
Read Time 21 MIN
Crypto, inflation and energy transition. We believe these will be the top themes of 2022 and present compelling areas of investment opportunity over the next few years, as CEO Jan van Eck discussed in his investment outlook. The transformational potential of each of these themes is immense and may be with us for the foreseeable future.
We have seen crypto disruption expand across the financial system and expect this to continue. The decentralized finance (DeFi) ecosystem is maturing and becoming a potential competitor to legacy financial intermediaries and global investment banks. 2021 also saw the first country, El Salvador, declaring Bitcoin as legal tender, and we would not be surprised to see another doing the same in 2022.
Inflation pressures may linger through 2022 and pose a risk of spiraling into a more persistent economic factor. Investors haven’t faced inflation risk since the early-to-mid 2000s, and the most notable inflation period prior to that was in the 1970s, which may mean that their portfolios are not positioned for a prolonged inflationary environment. Historically in these market environments, real assets—including natural resources and commodities—have outperformed stocks and bonds.
Average 12-Month Real Return When CPI Is At or Above Certain Levels (1969-1981)
Source: Bloomberg. Past performance is no guarantee of future results. The lack of a long index track record limits some of the data availability of some assets classes for this period. See definitions and disclosures below.
Average 12-Month Real Return When CPI Is At or Above Certain Levels (2003-2007)
Source: Bloomberg. Past performance is no guarantee of future results. See definitions and disclosures below.
Against this supportive macro backdrop for commodities, the energy and resources transition continues to progress. We believe this is creating a myriad of opportunities for investors along the way, from the green metals and minerals to fuel renewable energy technologies, such as batteries technology and electric vehicles, to sustainable agriculture and food production industries.
As investors plan their 2022 allocations, we spoke to a group of our experienced investment professionals to gather their insights on what to expect for their respective asset classes.
- Q: What will have the biggest impact on your outlook through the end of the year and for 2022?
- Q: What do you view as the biggest risks and opportunities?
- Q: Why should investors be considering your asset class now?
Q: What will have the biggest impact on your outlook through the end of the year and for 2022?
JOE FOSTER, PORTFOLIO MANAGER, GOLD STRATEGY: Inflation. The longer it persists, the more gold stands to gain.
DAVID SCHASSLER, PORTFOLIO MANAGER AND HEAD OF QUANTITATIVE INVESTMENT SOLUTIONS: The level of inflation and how the Federal Reserve (Fed) reacts to it will have the largest impact on the markets. The transitory argument is no longer credible. Inflation is high and broad. The year-over-year change in the CPI is 6.2% and almost all of the categories in the CPI basket are up over 4% this year.
Price instability has been identified as a key risk, and it will be met with less accommodative policy. However, less accommodative economic policy is not the same thing as restrictive policy. Trillions of dollars in fiscal spending, interest rates at zero percent and a Fed that is still purchasing mortgage-backed securities and Treasuries is creating, not fighting, inflation.
Allowing inflation to run too hot for too long will amplify the problems. If high inflation continues, which we expect, attempts at bold policy action will likely be met with market turmoil. The debt levels and political climate will make economically destructive policy action untenable. Therefore, we would expect inflation to be higher this decade than the last and, with that, a sustained bull market in real assets.
SHAWN REYNOLDS, PORTFOLIO MANAGER, NATURAL RESOURCES EQUITY AND ENVIRONMENTAL SUSTAINABILITY STRATEGIES: The resources sector remains highly leveraged to inflation and global growth—both themes which have dominated headlines and which have been significant drivers of performance over the last year and a half. Anticipated interest rate hikes and recently stalled recovery efforts (due to supply chain issues, the advent of COVID variants, etc.) have, we believe, only modestly impacted investor sentiment for now. Though we continue to believe that the prevailing macroeconomic sentiment will be one of higher-than-anticipated inflation and stronger-than-expected growth, we remain cautiously optimistic.
We are otherwise strongly encouraged by the fundamental, company-specific outlook for many of the names we follow in the space. We continue to focus on companies’ efficiency gains, historic free cash flow generation and commitment to capital discipline in the face of a dramatic rise in underlying commodity prices. Many of these same companies—and their associated sub-sectors—still continue to trade at a significant discount, too, to both their longer-term averages and relative to other sub-sectors.
ROLAND MORRIS, PORTFOLIO MANAGER AND STRATEGIST: Commodities had a very good 2021. Commodity index products are likely to continue to benefit from positive roll yield in the futures markets next year.
The outlook for inflation and global growth are the two most important factors influencing commodity markets. Inflation has become less transitory and more persistent in the U.S. economy as both wages and housing costs continue to rise. Global growth is likely to face some headwinds this winter, which could restrain global growth and demand for commodities. China is slowing as they struggle to deflate their leveraged real estate markets. Europe is facing some of the highest energy costs in decades this winter, which could rise even more if we have a cold winter, resulting in slower growth. Even U.S. growth could slow this winter as the emergency fiscal stimulus fades and the Federal Reserve (Fed) tapers quantitative easing, tightening monetary policy at the margin.
DAVID SEMPLE, PORTFOLIO MANAGER, EMERGING MARKETS EQUITY STRATEGY: Emerging markets countries will continue to normalize economic activity, as COVID-19 becomes endemic. We expect inflationary pressures to dissipate through 2022 in particular for emerging markets. China growth will be sluggish for one or two quarters more, but we expect increased policy softening to help secure better growth rates in 2022. If inflation persists for longer than we anticipate in the U.S., a more hawkish Fed, compared to other major central banks, would tend to be dollar positive and, consequently, unhelpful for dollar based emerging markets returns.
JIM COLBY, PORTFOLIO MANAGER AND STRATEGIST, MUNICIPAL BONDS: There are two issues that stand out that may potentially have the largest impact on municipal bonds in 2022:
- (POSITIVE) The newly signed infrastructure initiative will bring billions in municipal financing to the marketplace. This means that demand may potentially be met by supply, and bond valuations will be far more palatable in terms of spread and relative value for clients. This will be true for both investment grade as well as high yield.
- (NEGATIVE) The pace of economic recovery will continue to pressure the Fed to remove accommodation, likely pushing rates higher and bond prices lower. While this happens, it will potentially have a dampening impact upon bonds and investment.
ERIC FINE, PORTFOLIO MANAGER, EMERGING MARKETS BOND STRATEGY: The Fed. If they hike earlier than expected, which we reckon they will do, that will push up front-end interest rates and the U.S. dollar. It will be viewed as risk-off for a lot of emerging markets. But, it might not be that bad for the U.S. economy, as there remains a lot of fiscal stimulus.
FRAN RODILOSSO, CFA, HEAD OF FIXED INCOME ETF PORTFOLIO MANAGEMENT: For fixed income markets, there is no doubt that the path(s) the Fed, and potentially other developed market central banks, take towards exiting ultra-accommodative monetary policies amid the prospect of rising inflation will be a major factor for the next year and beyond. While it is possible that the narrative around inflation replaces the term “transitory” (which has already been disavowed) with “base effects,” which would be to suggest that higher prices remain in place but the pace of increase decelerates, inflationary expectations one way or the other will be a key driver of bond market returns.
For now, we continue to favor credit over duration within fixed income, but after the spread compression experienced in 2021, we caution against straying too far out the credit curve. The continued global response to COVID-19, vaccination rates and the emergence (or not) of concerning variants will greatly influence our currently positive views on global growth going forward. We are also very interested to see how a couple of longer-term trends influence the make-up and evolution of debt capital markets. Regardless of the reasonableness of the zero net emissions by 2050 goal, the transition towards renewables and electrification is irreversible. We believe the scope of investment will be unprecedented, and we expect to see exponential growth in green financing starting now. The evolution of blockchain based financial services should begin to lead to new product and investment ideas. This notion does not concern the proliferation of digital currencies, which while significant is also highly speculative.
MATTHEW SIGEL, HEAD OF DIGITAL ASSETS RESEARCH: Economic activity on open-source blockchains accelerated in 2021, as we estimate close to $8T have been sent across the Bitcoin and Ethereum networks this year. Individuals, corporates and sovereigns have begun to realize the cost and speed savings associated with digital assets, but overall penetration rates are still extremely low.
We believe the fundamental momentum is sustainable into 2022 as institutional investor capital is turbocharging adoption thanks to venture capitalists funding emerging use cases, including credit card rewards, gaming, NFTs, sports ticketing, and DeFi. Meanwhile, with the Ethereum network highly congested, many alternative “layer 1” blockchains such as Solana and Avalanche are executing on their promise of faster network speeds and lower transaction costs. The key question remains: what will be the killer (decentralized) application that onboards a billion users into crypto? For perspective, only 5M users accessed the largest DeFi exchange (PancakeSwap) in November.1 It is still early.
Q: What do you view as the biggest risks and opportunities?
MORRIS: The biggest risks are slowing global growth this winter, but inflation is likely to continue to support commodity markets. There are several factors that should support commodity markets next spring and summer. Supply may continue to be tight in most markets and in the energy markets in particular, where OPEC’s spare capacity may likely disappear. Longer term declining production of oil and gas combined with growing demand for industrial metals due to energy transition may keep commodity markets volatile and exciting.
FOSTER: Biggest risk to gold is a rate hiking cycle that doesn’t damage the economy or the stock market, which we see as a low probability. Biggest opportunities are gold miners, which are trading at historically low valuations, despite their strong financial outlook.
REYNOLDS: In our view, the biggest opportunity within the global resources space remains in the sub-sectors most closely tied to the ongoing energy transition. The move to renewables is accelerating, propelled by expansive—and increasingly mandated—climate policy, as well as by increased consumer demand and easing of access. We believe that the energy transition will continue to disrupt the supply and demand dynamics for a host of associated industries, as countries and companies increasingly compete for clean energy substitutes and as the number of key minerals required to facilitate the buildout of these technologies and support systems becomes fully appreciated by the markets.
We believe that one of the biggest risks to the space in the near term is the impact of sustainable investing on extractive industries such as diversified mining or oil and gas production. We believe that companies in the traditional resources space have gone to much greater lengths to detail their efforts related to various sustainability issues, though acknowledge that the investing public generally seems inclined to just avoid these types of investments altogether. In the face of an energy transition path that requires an unprecedented demand of metals, minerals and traditional energy resources to see it through to full completion, to us, it seems a little premature to ignore the investment opportunities across the broad resources spectrum.
SCHASSLER: The extreme expansion of the money supply reset market valuations higher as more money overwhelmed the markets and sent asset prices soaring. High flying growth stocks were disproportionately impacted by the flood of liquidity and are now particularly vulnerable for when the yield curve adjusts upwards to the higher inflation regime and puts further pressure on valuations.
We believe gold equities are the biggest opportunity for investors in the current environment. Gold is the classic safe-haven, store-of-value asset. Yet, due largely to the Fed’s “transitory” campaign, most were convinced that inflation must be temporary and this muted overall investment demand for gold. We expect that to change as consumers adapt to the higher inflation regime. Gold may be the largest natural beneficiary. Gold companies offer one of the few potential pockets of value, in my view. And, we believe their financial strength supports significantly higher prices without the price of gold rising.
COLBY: The opportunity for investors to better equate risk and value in widening spreads comes with increased supply. Value not seen in three to four years will potentially emerge. The risk that, with rising rates, the market moves too far too fast will – as it historically has – present great opportunity to reinvest and benefit from a corrective rally , creating positive returns or diminishing negative ones.
FINE: The biggest risk to the emerging markets debt market is a Fed that hikes early. It boosts the dollar. It boosts front-end rates. Many will say a hawkish Fed will push the entire yield curve up. We disagree. We think only front end-rates and the dollar get pushed higher. Long-end bonds might not rally, but they are not the way to bet on Fed hikes. The market is betting that way – paying rates as their way of expressing their expectation of a hawkish Fed. Pain trade ahead – they will be right on the news, and wrong on the trade. As a blend strategy, we should be able to deal with this simply by having low local currency (which we do) and comfort with duration. Also, we are super-excited that the Chinese property sector blow-up we anticipated has happened and have found very attractive bonds in that not bombed out sector.
RODILOSSO: With regard to risk-free rates, the larger risk for markets is not whether the Fed withdraws liquidity or hikes rates at a more rapid or slower pace, but whether or not the market perceives that they have waited too long, leading to an acceleration of inflation expectations and/or rate shock potential. Rate volatility would be far more damaging to returns for diversified bond investors than higher rates alone would be.
If history is a guide, though, spikes in interest rate volatility may lead to bouts of spread widening that bring overall value and pricing dislocations into various markets, such as investment grade and high yield corporates, as well as emerging markets. In that case, we believe buying opportunities could emerge in these asset classes, particularly high yield and emerging markets credit. Floating rate products may remain attractive for investors seeking to mitigate potential rate volatility, and we believe investment grade floating rate notes might be the most attractive solution for investors not looking to add as much credit risk. For those with an appetite for more credit risk, business development companies (BDCs) represent equity upside to compensate for the risks associated with leveraged lending.
Many of the other risks to our base case view of continued economic recovery and interest rate normalization would likely dampen expectations for higher rates, and would lead to slower growth expectations and generally be more negative for credit and mixed for emerging markets. Such risks include global health (COVID, low vaccination rates), politics (government funding, legislative gridlock, mid-term election noise), geopolitics (China and Russia related issues in particular) and natural disasters.
SEMPLE: Emerging markets are an unloved asset class, and China, in particular is viewed unfavorably, in part because of overdue and heavy handed regulatory activity. Looser monetary, fiscal and regulatory policy can create an inflection point for some compelling valuations in China. Geopolitics are always a factor, but we see the prospect of a “hot war” over Taiwan Region as being very remote. Sustained easing of inflationary pressure, vindicating the Fed’s stance, would be positive for emerging markets, in our view.
SIGEL: First the opportunity, which is enormous: Summing global retail banking (ex-mortgages and payments) revenues of $1.4T, global payments revenues of $1.1T, global investment banking and trading revenues of $500B2, and asset manager revenues of $130B3, one arrives at a total banking top-line of $3T (3.4% of global GDP and 3% of global investable assets)4. Against that, Ethereum mining revenues are on pace to surpass $18B in 2021, representing 60bps of the global banking pie.5 Given the scope for decentralized financial networks to compete on price vs. high-cost developed market banks with their 60%+ cost/income ratios, and the prospect for addressable market growth as additional revenue streams get tokenized, is it too wild a stretch to imagine 5% dollar share for non-Bitcoin blockchains in five years? Alternatively, the banking revenue pie could shrink by as much as 20%, thanks to the deflationary impact of the blockchain, and digital asset platforms might take a larger 7.5% dollar share of a more efficient system. Those two scenarios would produce annual non-Bitcoin blockchain network fees of $145B - $180B.6 Assuming Ethereum captured two-thirds of this value and holding the ETH market cap/revenue ratio steady at its current 19x “sales” would yield an ETH enterprise value between $1.8 – 2.3T vs. its current $500B market cap.7
The risks are two-fold: monetary policy and crypto-specific regulation. On the former, growth outperformance vs. value has been negatively correlated with bond yields since COVID.8 That is, when yields rise, growth underperforms. Given the high correlation between digital assets and the Nasdaq this year, a disorderly move higher in rates could spook investors away from digital assets. On crypto-specific regulation, the current SEC is clearly warning that additional enforcement actions against non-compliant digital asset protocols are likely in 2022. Although the political winds may be improving with multiple lawmakers from both parties advocating a more free-market approach to crypto, nevertheless a hostile U.S. regulator might present some headwinds to the growth of the ecosystem.
Q: Why should investors be considering your asset class now?
SCHASSLER: We should expect the inflation of the next decade to be higher than the inflation of the last decade. Therefore, a different investment playbook will be required. It would favor investments that can quickly adapt to, and even benefit from, higher inflation. Those that cannot will suffer. The inflationary pressures on most companies should become more apparent the longer this continues as they struggle to absorb and pass along inflation.
Historically, the top inflation beneficiaries have been: resource real assets (commodities and natural resource equities); financial real assets (gold bullion and gold equities); and income producing real assets (REITs and infrastructure). Bitcoin—which is often viewed as digital gold—should also be considered, albeit in moderation.
REYNOLDS: Inflation is persistent and pervasive… but it is almost never permanent. A defining trait of resource equities are their ability to act as a hedge against inflation. Historically speaking, resource equities have outperformed most other asset classes in modest inflation environments (between 2% to 6% inflation, year-over-year) and significantly outperformed in high inflation environments (greater than 6%, year-over-year), as seen in the two charts above on returns when the CPI reaches certain levels. Based on recent trends, we may currently be amidst one of the more significant inflationary periods seen in the last 40+ years.
FOSTER: Rarely in history has the financial system been in such a precarious state. Central banks and fiscal policies have pumped up the markets and juiced the economy. As central banks begin to rein-in the liquidity, it could all come crashing down. I believe, Investors should be considering a hedge, like gold, against these systemic risks.
MORRIS: Investors should consider adding to their commodity exposure for a couple of reasons. First, they are likely to continue to provide positive roll yield due to tight spot market supply. Second, global central banks may have difficulty fighting inflation due to the highly leveraged global financial markets and high debt levels. This will constrain their ability to raise rates, potentially risking much higher inflation globally.
SIGEL: The classic 60/40 equity/bond portfolio is under attack. Since 2009, a 60/40 mix and a 100% equity portfolio both had Sortino ratios of about 1.6x9, meaning annual returns were 1.6x the downside portfolio volatility. In other words, the lower volatility gained by owning some bonds didn’t make up for significantly lower total return in equity bull markets. Reflecting this reality, VanEck has long argued that a 1-5% portfolio allocation to Bitcoin makes sense for most investors, given the structural challenges presented by these 0% rates. Now, with open-source smart contract protocols such as Ethereum accelerating their market share gains from traditional banking, payments, brokerage and Web 2.0, we increase our allocation recommendations to include an additional 1-5% in cryptocurrencies analogous to the growth equity component of an investor’s portfolio. For this bucket, we believe a diversified basket of smart contract protocols (Ethereum, Solana, polkadot, Avalanche, Algorand, etc) such as that represented by the MVIS CryptoCompare Smart Contract Leaders Index is a reasonable place to start.10
FINE: Where else are you going to go? Seriously. If you don’t like your 60/40 model, fine, take the 40 down. But whatever is in bonds should be in emerging markets bonds. Historically, they yield more and they have less debt. We also believe, they manage economic policy well. Their dollar bonds have been the best performing market for three decades.11
RODILOSSO: Credit fundamentals are improving, and with many companies still tapping capital markets to push out maturity profiles, a growth/inflation environment will further bolster credit profiles across many sectors. For that reason we believe the carry and low correlation with Treasuries that characterize high yield bonds make it a relatively attractive place to remain over the near to medium term. We believe that, since the few true capital gain opportunities in the space reside mainly in upgrades and especially credit transitions, rising stars are becoming almost as big a story recently as fallen angels were in 2020. With a much higher concentration of potential rising stars, fallen angel bond strategies are currently outperforming and potentially poised to continue to outperform broad high yield strategies.12 With a high BB allocation, these strategies also may prove to be more defensive should there be a meaningful credit downturn.
Should a rate shock or other factors lead to the type of pricing dislocations mentioned earlier, then credit strategies that systematically seek attractive valuations amid the fallout should have scope to outperform. Investment grade floating rate notes solve the duration problem with higher credit quality exposure. We also see the growth of green bonds accelerating rapidly over the next several years, adding diversification and liquidity to a forward-looking credit portfolio that has proven thus far to play a positive role within global bond allocations.
Finally, emerging markets local debt, after a meaningful spate of rate hikes in 2021, bears watching for tactical opportunities at the very least, and more strategic ones should dollar strength be undone by disappointing growth, political factors or other reasons. Emerging markets is where the biggest rate adjustments have already occurred, real interest rates remain in positive territory, and where there is some steepness to curves as well. These conditions make for a far better carry story and leave greater potential for capital gains should rates start coming back in. China as a stand-alone allocation proved to be a resilient one in 2021. As the world’s second largest bond market, and with the rate gap versus U.S. and Europe still attractive, we believe there will be, and should be, increasing interest in CNY bond allocations.
SEMPLE: The emerging markets equity asset class is cheap and unloved relative to the U.S. market in particular. A constantly negative narrative, particularly around China, will likely reduce in intensity. Emerging market economies are in good shape, having pursued economic orthodoxy and indulged less in the huge fiscal surge of other countries – there is less of a punch bowl to take away.
COLBY: The attraction is still strong with tax exempts because no new legislation has yet passed – nor seems poised to do so – that might alter the equation of items of deductibility ( S.A.L.T.) or individual tax rates. With rates rising, points of entry are looking more attractive for municipals. As the new infrastructure funding stimulates more issuance, investors will have a broader variety of issues to consider at better relative value. I believe short high yield bonds and intermediate investment grade bonds represent two areas that will be a good focus for at least the first half of 2022, as their respective spots on the yield curve offer protection against rising rates and lengthening duration.
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23 September 2021