Beware: things are not normal

This is not a normal environment – and there is no reason to think it should be. The last decade has seen a variety of extraordinary monetary experiments and the last two years have jumped every possible shark. We’ve seen rolling economic shutdowns, a new level of quantitative easing (QE), helicopter money, insanely-low interest rates, the biggest recession ever, and of course, the biggest recovery ever.

We’ve watched vast fortunes being made in tech stocks and in cryptocurrencies – and of course, in housing. Now we have supply crunches, the (fast) return of inflation, a shift in power from capital to labour, and one hell of a pivot from behind-the-curve central banks. With all that in mind you should not be particularly surprised that markets are all over the place, or for that matter that seeing through the noise is tricky.

It is hard to know what to do. However there is one thing it is increasingly clear that you should not do – and that is to retreat to the perceived safety of the assets that have done you well over the last few years. There is a strong chance they won’t do the same over the next few. Which assets do I mean?

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First up is US stocks and tech stocks in particular. Keeping too many of these, says Ben Inker of GMO, is likely to be the first big mistake investors make in 2022. Their outperformance in 2020 and 2021 cemented the idea that they are the lowest-risk, highest-return version of equities ever – and recent volatility aside, a safe long-term option. But their outperformance has also made the US expensive – and so remarkably unsafe. You would be better, says Inker, to cut your US exposure and move into China and emerging market equities (much cheaper).

Beware frothy valuations

Next is private equity and venture capital. Those worried about the future might see that some institutions have made fortunes here and pile in too. There are all sorts of problems with this (the difficulty of selling private assets in tricky times being an obvious one). But the key thing is price: valuations are “frothy” – too frothy to compensate for the risks. Remember too that the exit route for private equity (the bit where you get the money) is via public markets. If public markets aren’t prepared to pay as much for growth as they were (that’s why tech stocks are falling) private equity valuations obviously have to fall too. This is not a safe place to be.

Third is US bonds. When markets fell in early 2020, US Treasuries were “wonderfully protective.” But the main reason bonds outperform in bad times is because central banks can and do cut rates into the downturn. This option wasn’t available in the likes of Switzerland and Sweden in 2020. The result? Their “previously reliable defensiveness” was no longer available. That may now be the case with Treasuries. They protected you in 2020. They probably won’t in 2022.

Eagle-eyed readers will have noticed something here – the core problem with all these three things is price. A bond can only protect you if it isn’t already horribly overpriced. A very expensive growth stock can only keep making you money if investor perception of the value of that growth doesn’t change. A private equity investment can only make you money if you don’t overpay for it. You can only think that these things are safe if you think their price doesn’t matter. It usually does.