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Five wild calls for 2022

Apart from new variants, what are the curveballs markets could face next year?
Five wild calls for 2022

We’re at that point of the festivities when you’re cornered by that conspiracy theorist uncle, brother-in-law, or colleague who’s somewhat worse for wear. You know the conversation: outrageous Illuminati prophesies interspersed with hiccups and blue humour.

Don’t dismiss conspiracy types completely, though. Some of them had their fingers on the pulse 10 years ago before populist anger helped sweep Donald Trump to the US presidency and the United Kingdom out of the European Union.

Asking yourself ‘what if?’ is a wise part of the investing thought process. Turning to sensible commentators, no one expected a global pandemic when Ranu S Dhillon, Devabhaktuni Srikrishna and David Beier wrote in the Harvard Business Review that it was a risk for which society was ill-equipped (‘The World Is Completely Unprepared for a Global Pandemic’, Harvard Business Review, 15 March 2017).

Fundamentally, the purpose of investing is to be better off in a future that can’t be perfectly foreseen. So, while you may put this list down to a few too many sherries, it is still worth pausing to consider if your portfolio is robust and nimble enough for whatever may spring out of the leftfield.

 

UK government to grab a property tax windfall?

Some might say this call is sensible but unlikely, given the government’s unpopularity with a public exasperated by restrictions on freedom and the behaviour of those in power. That said, if the UK Treasury is serious about reassuring the country’s lenders, there is a case for new wealth taxes.

Realistically, raising taxes on shares doesn’t make sense. It would simply force wealth out of the UK, raise companies’ cost of capital and run counter to the government’s objectives to make London more attractive as a destination for companies to list and raise funding.

Taxing property is more feasible, at least physically. Homeowners have enjoyed a long boom and the Resolution Foundation estimates £3tn in property wealth has accumulated in the UK since 2000 after allowing for consumer price index inflation.

No politician would dream of initiating a retrospective windfall tax on gains of that scale. If they were to rebase home values to a cut-off point, however, it might be more palatable. If a line was to be drawn from the start of 2015, for example, a sense of perceived injustice by long-time homeowners could be avoided, but unearned gains from Help to Buy fluffing the housing market would be captured.

Psychologically, the idea that ‘my home is my castle’ may be too much to overcome. Still, some form of contingency to capture future housing gains may be wise in the view of Emma Chamberlain, barrister at Pump Court Chambers, who argued for a pragmatic approach at a recent Resolution Foundation panel.

Advocating simplicity, Chamberlain argued for higher exemption thresholds to capture fewer and wealthier people and suggested that if it was only politically possible to tax future gains, that would be better than doing nothing. Perhaps the housing market has finally peaked, and so taxing only future property gains wouldn’t make a dent in the deficit. But regardless of what could be raised from year one, letting bond markets know there are no sacred cows would be a powerful gesture to signal Britain is a safe long-term investment.

 

'Loan tokens' hint at the future of leverage and liquidity

From ‘safe as houses’ to the latest exciting but mind-boggling innovations in decentralised finance (DeFi).

On 1 December, Singapore-based blockchain DeFiChain announced a new “loan token system” that claims to be the world’s first to be devoted to decentralised monetary applications and services for bitcoin. It is a native (ie, standalone) blockchain but connects to the bitcoin network via something called a Merkle root.

DeFiChain believes token trading can provide greater liquidity for cryptocurrencies and access to financial assets including real estate, commodities, bonds, precious metals, forex and equities. While that sounds significant, it’s also highly technical and regulators may struggle to keep tabs. 

The system facilitates the minting of tokens to trade fractional values of traditional assets. The tokens are collateralised loans, requiring twice their face value to be covered by a basket of digital assets which can include bitcoin, ether (the native cryptocurrency of the Ethereum blockchain) and various US dollar stablecoins. But half of the collateral must be in DFI, DeFiChain’s native network token.

No ownership is conferred over the underlying asset, so it is essentially a self-regulated marketplace that aims to simulate the value of traditional assets and trade them without charges. How a basket of volatile digital assets can possibly underpin accurate synthetic replication is a puzzle, as is the incentive for people to put up two-to-one collateral in the first place.

What’s also intriguing is the idea of linking traditional asset prices to crypto in this way. If scale is achieved, it could be a way of naturally flowing traditional asset liquidity into crypto markets. It could also have an impact on mainstream assets. As DFI matures and as other cryptocurrencies such as bitcoin get ever-more established, the collateral mechanisms could be flipped around to instead allow users to make leveraged trades on traditional assets and fund margin calls with their crypto.

A major concern, however, is the role of so-called stablecoins in funding the collateral and lubricating some of the pricing and settlement on the exchange. These coins are ostensibly pegged to the US dollar, but the quality of the assets that back them has been questioned. For projects such as this to achieve scale, there must be no doubts about the integrity of the assets they are built on.

 

Super fintechs to hammer the banks

Higher interest rates are on the cards, which is good for banks’ profits. But coming from such a low base any positive impact could be trumped by new threats on the horizon. In its ‘Top Trends in Retail Banking: 2022’ report  Capgemini has highlighted the rise of the ‘Superfintechs’, the maturing digital-first competitors making a play for the growth areas of retail banking.

Financial technology, or fintech, can basically be defined as financial services led by technological innovation, especially (although not exclusively) those driven by the mobile internet. Many start-ups in the space are unlisted and have acquired unicorn status (an equity valuation of over $1bn (£750m)), capturing the imagination of investors as well as consumers. Now the likes of Revolut and Starling Bank are achieving operational scale, too. They have the customer base, market share and revenues to be seen as threats to the banking incumbents.

In its report, Capgemini identifies transformative trends such as banking-as-a-service (BaaS), 5G mobile and the ongoing regulatory quagmire of moving to cloud-based systems as immediate challenges. Further out, there is the potentially revolutionary impact of DeFi, whereby lending and financial services are provided on blockchains. This might not mean an end to intermediaries in finance, but it is perhaps a great opportunity for new ones to emerge.

Back to the here and now: when you  consider the growth and capital-raising potential of the likes of Revolut (which in its last funding round was valued at $33bn, more than NatWest), Square, Starling Bank and Stripe, the incumbent banks have a real fight on their hands. They may not be going obsolete – customer inertia will see to that – but are these companies that can grow significantly? The investment case for the kings of the fading high street era will rest on dividends, but as recent history demonstrates, payouts from banks can’t be considered a sure thing.

 

More clashes as ESG joins the culture wars

The increasing focus on environmental, social and governance (ESG) factors is another headwind for established banks, along with many other parts of the economy, which must adapt if they are to achieve net-zero carbon targets. Lenders are increasingly targeted by activists for funding the fossil fuel industry. Scrutiny is warranted, but there is a danger that essential dialogue for dealing with the climate crisis becomes a shouting match.

First of all, it’s worth focusing onthe positives that came out of the 2021 United Nations Climate Change Conference (COP 26). Central banks are to exert meaningful pressure on commercial lenders to consider climate impact and the new International Sustainability Standards Board will demand better disclosure and measurement by companies. 

Activists may have wanted an instant end to thermal coal and to further oil exploration, plus binding commitments to phase out fossil fuels entirely, but that was never realistic. That’s not to say all of these things aren’t essential. There must be a roadmap and non-governmental organisations play a vital role in insisting companies commit to staging-post targets in meeting their net-zero commitments. If they aren’t aligned with science on limiting global warming to 1.5 degrees Celsius and held to account on measuring progress, the promises are empty.

The trouble is, with humanity facing such an existential crisis, there is an anthropological element brewing, and saving the planet is being bound up with other causes that have less buy-in from business and the wider public. While one tribe is shouting for an end to capitalism and borders, the other is free to crank up its slick public relations machine and own the narrative on climate change. That’s dangerous as, unchecked, asset managers and companies can slip into bad old ways and greenwashing activities. 

 

Le Pen wins in France

President Emmanuel Macron of France is engaged in macho posturing with Boris Johnson over fish and Northern Ireland, but this may not be enough in his bid for re-election. On 8 December Politico EU’s poll of polls had Macron only beating National Rally candidate Marine Le Pen by 10 percentage points in the second round of voting.

Polls haven’t had a great record of predicting elections in the past decade, so will be of little comfort to the incumbent given the tightness of the race and the direction of sentiment. In 2017, Macron received almost twice as many votes as Le Pen in the second round after he emerged as a fresh candidate untainted in politics. This time around, the former banker and arch globalist is especially vulnerable to the rising tide of nationalism.

That swell of feeling favours Le Pen and the political centre of gravity has shifted her way, with first-round votes diluted somewhat by the conservative Les Républicains party’s choice of Valérie Pécresse, who has also sounded tough on immigration. For the far-right plinth, Le Pen is competing with the candidacy of polemicist Éric Zemmour.

The Omicron variant of coronavirus couldn’t have come at a worse time and the president mustn’t put a foot wrong in the next four months. As the 2018 gilets jaunes protests showed, the French public are sensitive to policy missteps and Macron’s re-election cannot be taken for granted.