Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life. I’m your host, Allan Janssen.

For today’s Soundbites, part two of my conversation with Michael Arno of Brandywine Global Asset Management, and Jennifer O’Hara Martin of T. Rowe Price. Michael is an associate portfolio manager and senior research analyst on Brandywine’s global fixed income team. Jennifer is a vice president of T. Rowe Price Group, and a portfolio specialist in the company’s U.S. equity division. Last week we discussed opportunities that may await us in 2022. This week we tackle risks. I started by asking how we should approach the market.

Allan Janssen (AJ): Jennifer? Let’s start with you. This year was fraught with a lot of risk from new Covid variants to supply chain issues to social unrest. Is 2022 poised to be another risk-fraught year?

Jennifer O’Hara Martin (JOM): Well, you know, it’s often quoted the only certainty in life is uncertainty, and clearly the same could be said of investing. The last 18 months has reinforced [that] investing always involves risk, but with risk comes opportunity. While we can’t know for sure what’s in store in 2022, several factors will remain in focus and could shape the investing landscape. For example, vaccine effectiveness, U.S.-China relations, monetary and fiscal policy distortions. There will always be risks in the market, but due diligence, combined with a healthy balance of prudence and pragmatism, will form a steady foundation for global investors as we enter 2022.

AJ: Very good. Michael, what do you think? We had a lot of risk in 2021. Are we headed into another year like that?

Michael Arno (MO): Yeah, I think, unfortunately, we’ll be talking about a lot of the same issues for least part of ’22. ’22 is also going to be marked by the end of QE [quantitative easing] and fading fiscal stimulus. Regarding supply chain issues, China is maintaining that zero-tolerance policy. The other day I saw some reports out of China with some Covid cases which led to some plant closures. If we see a wave of cases followed by closures at plants and ports, we’re going to continue seeing supply chain issues. And since we’re all shipping logistics experts at this point, we continue to see ships queuing off the West Coast. It just seems like the U.S. distribution network is unable to catch up. So, we think inflation is going to be key for the months ahead.

AJ: Are social or societal risks poised to intensify in 2022? And how does ESG fit into the picture? Michael, what do you think?

MA: Yeah, regarding the societal risk for ’22, Covid has pushed millions of people back into extreme poverty in parts of the world. Looking at economic conditions and inflation rates, unemployment, the overall quality of governance in some places points to a potential for social unrest. So, we think that’s definitely a factor that, when investing in some of these countries, that one needs to consider. On the ESG side, governance has always been important, whether you’re investing in a company or a sovereign. But it’s really the environmental and social side that’s really been elevated when considering investments. Going forward, companies and sovereigns are definitely on this now. They’re providing better disclosures, more reporting. We think that the information available will just continue to improve and will help push some of these companies and sovereigns towards the direction where markets are going.

AJ: And, Jennifer, what’s your view?

JOM: Well, in our view, integrating ESG is crucial to finding good growth companies. Businesses will need to think carefully about their effect on industries, people, and ultimately the planet. Companies that understand these connections are often the innovators that are positioning themselves for real and future growth. We believe this is a very good disruption. Identifying how company or issuers position to navigate specific ESG issues will also really inform their prospects for future success. There’s a lot to say here but it’s a really, I think, noteworthy question in light of all that’s happened in the last few years.

AJ: Do you see a lot of political risk on the horizon?

JOM: I would say one that is relevant, is U.S.-China and the geopolitical relationship between two superpowers which continue to create pretty complex dynamics for multinational corporations. And it’s become very clear that underlying tensions between these two nations are real, structural, and unlikely to be resolved with ease. And so this is an area that we continue to monitor for both risk and opportunities.

AJ: Michael, same question. Are politics a big consideration when you’re looking at opportunities?

MA: Yeah, absolutely. And not to rehash what Jennifer was highlighting, the geopolitical posturing between China and the U.S. is very important. Russia’s build-up along the Ukraine border will be interesting to watch. You’re seeing the delivery of gas in Europe being an issue, and we all know what gas prices have been doing in the U.K. and throughout Europe as well this winter so far. And emerging markets, you know, there’s definitely a rise of political pressure for more social spending. You’re absolutely seeing that in a number of countries. So definitely see some pressure on spending and a shift to the left in a number of places around the world. And you know, finally, in the U.S. with the fiscal support winding down, consumers running through their savings, maybe we’ll start to see some more pressure for programs at the lower end of the income segment. So, these are some of the factors we’re thinking about. The political risks are always an important factor when investing in global bond markets.

AJ: Yeah, thank you for that. Those are some political trends. What about economic trends? Is there anything that you’re keeping your eye on that could come into play in 2022?

MA: Yeah, I think what’s interesting in the U.S., one of the things you saw for the first time ever was incomes rise during an economic slowdown. That never really happens and that was led by governments providing direct income support. So, this is probably going to be a fiscal tool going forward. And I think that’s that is a huge possible trend. This development is interesting.

AJ: And, Jennifer, what about you? What economic trends are you watching?

JOM: If I think about the changing media, entertainment, and the communication landscape, we believe these lasting behavioural effects from the pandemic will accelerate the long-term trend of streaming video that’s going to take share from traditional television and really exaggerate the ongoing shift towards digital advertising and E-commerce. And we think the market still underappreciates this profound effect the pandemic has had on the consumer landscape, and believe it is vital for companies to view these businesses through an omnichannel lens, ignoring an online presence could prove very detrimental. If you look at the advancements in areas like artificial intelligence or machine learning, enterprise software, it’s not only affecting tech companies but also reshaping more traditional industries once viewed as less susceptible to business-model disruption. And this includes the health care industry which is much more than just a group of traditional drug companies. And the other thing, you know, kind of tying it back to an earlier question you had, was consumers and investors are increasingly emphasizing the importance of corporate sustainability. We’ve seen real increasing pressure on corporations to do good or do better. And it’s a trend that does not show any signs of receding. It is likely that we will continue to see companies innovate, evolve their businesses in order to improve their ESG profile. And it’s reasonable to expect that this trend will naturally lead to a migration of assets to sustainable or impact funds.

OK. So, to round this out, what is the bottom line on risks for 2022? Michael, what do you think?

MA: I think the biggest risks for ’22 are going to be inflation, the speed of inflation, whether it accelerates, and how that ties into Fed policy. So, I think that will be the one key. And then the other important one is China. We saw a credit impulse drag for ’21. That has knock-on effects for countries around the world. Seeing their change in policy in ’22 could offset some of the tightening that we’re seeing in developed markets, however it just depends on the degree of fiscal stimulus they take. So, we’re watching that impulse data pretty closely.

AJ: Very good. And Jennifer? What would you say to a room full of investors?

JOM: We expect the markets to remain volatile, given the ongoing pushes and pulls across such large dimensions as the virus, inflation, geopolitics, and valuation. We look to be balanced within the portfolio, keeping the overall portfolio beta near one, and focusing on bottom-up stock picking to generate alpha.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Michael Arno of Brandywine Global Asset Management, and Jennifer O’Hara Martin of T. Rowe Price.

Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our AM newsletter and never miss another Soundbite. I’m Allan Janssen. Thanks for listening.

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