This is a piece written in December 2021 while I was the Executive Director, Chief Investment Officer at the Geneva Magement Group.

Foreward

Forced, planned and unexpected transformation

In the year 2022 and beyond the globe, the global economy and global markets will likely undergo forced, planned, and unexpected transformations, unlike anything witnessed in recent history. Only select economies can quickly adapt, innovate and thrive, experiencing broad, overall growth.

The change and transformation that are in motion will remain in play for the foreseeable future. Formidable forces are driving this transformation, creating tremendous disruption, divergence, and divisions in an age of debt levels at historic proportions in nearly all emerging and advanced economies.

While pandemics and crises, in general, pose significant threats, they also trigger great innovation, adaptation and thus positively transform our world. However, not all governments and organizations adapt, innovate, and change or do so fast enough. Widespread divergence and disruption across economies and industries is a by-product during periods of transformation. Organic growth will surface more readily in countries with the most business-friendly and adaptive environment, especially those primarily driven by domestic consumption. At the same time, new alliances will forge stronger trade relationships or fortify old trade routes. Quality countries and companies that can adapt and innovate will thrive.

Investment strategies and portfolios must be constructed or adjusted accordingly. Indeed, portfolio managers will need to adopt a more active portfolio management for the year ahead.

Understanding transformative forces

Divergence

The global policy response (health, monetary, and fiscal) to the pandemic has been uneven. When combined with new national and economic security and strategic initiatives, differences in the pandemic response are most significant. All combined, the economic landscape across regions varies considerably. Thus, economies are moving at different speeds. Economic performance divergence will continue indefinitely; business cycles will continue to be less synchronized.

How we’re responding

A higher degree of active portfolio management is required as business cycles are moving at different speeds and vulnerabilities have increased. Vulnerabilities and risks that stand out and are most concerning include financial market valuations and possible asset bubbles, government debt levels, unexpected inflation shocks, supplychain complications, global security issues, more aggressive national security strategies, increased risk of cyber security & IT infrastructure failures, higher risk of extreme climate events and infectious diseases.

Disruption

The global policy response to the pandemic has been uneven, coupled with shifts in geopolitical strategies and alliances, rapid technological change, and a global march towards a cleaner, greener, and more equitable planet. Together, these factors are creating a tremendous disruption across regions, economies, industry, and sectors. In addition, technology is democratizing information, knowledge, education, and finance. Disruption, therefore, is sprouting in all regions and all parts of the global economy.

How we’re responding

As with divergence, disruption creates tremendous opportunities. We favor an allocation to countries and companies that adapt and innovate and thus are wellpositioned to benefit in this age of great transformation. Quality institutions with improving or robust governance and strong environmental and social policies will not only do well but will have lower downside capture in down markets.

Our investment strategy focuses on agile and advanced economies, where we remain invested, primarily favoring innovative, adaptive companies. We stay with our value and quality bias, primarily focused on cyclical sectors. At the same time, we also prefer any quality companies across industries participating in the global transformation towards a greener, cleaner, and more equitable world.

Divisions

The 2020 global crises, both health and debt, have surfaced and accelerated several nascent geopolitical divisions that had been formulating for years. Moreover, the stress and burden of managing economies during times of crisis have turned many nations inward, focusing on supporting, fortifying, and reinvigorating sections of economies deemed vital for national economic security.

While all governments have had to address vulnerabilities in their economies brought to the surface during this crisis, China and the USA are the most significant. The US and China seem to be decoupling. Both are pressing their main ideological allies and partners to align and provide support in what appears to be a severe growing rivalry.

Over the past several years, the US has increasingly prohibited China’s involvement in parts of the economy it deems vital to national and economic security. The EU, UK, and other democratic states in the D-10 have also pivoted in this same direction.

This geopolitical backdrop will continue to evolve and may exaggerate divisions forcing global trade flows to change direction with implications across regions, economies, sectors, and currency flow.

How we’re responding

Divisions taking shape may more clearly alter trade flows. For example, the D-10 group of countries may look to increase intergroup trade at the expense of China. How countries pivot and change positions will impact corporate behavior. While we expect divisions to continue to evolve, the investment portfolio can benefit from solutions focused on corporates following government pivots and rapidly moving business activities. Countries with strong, robust domestic, organic growth are safer and more prudent for investment opportunities as they will experience fewer headwinds from sharper geopolitical divisions.

 Debt

The global COVID-19 pandemic, which began in 2020, has been closely followed by a worldwide debt pandemic. Countries, strong and weak, issued a historic amount of debt to support economies. Since the pandemic’s start, global debt, government, business, and household growth has been massive. In 2021, global debt has continued to climb, reaching USD 296 trillion, more than USD 36 trillion above the pre-pandemic level. At the same time, 2020 saw the most sovereign rating downgrades in history, mainly in emerging markets. Thus, government and central banks are increasingly anxious about debt servicing costs, especially in a world that seems to be gripped by higher trending inflation. Given the growth and higher prices environment, several emerging and developed market central banks abandoned the hyper accommodative policies and have already moved policy rates higher. More widely,market expectations of monetary policy have shifted, with many rate hikes now being priced for central banks in both developed and developing economies for the year 2022.

However, investors need not worry yet. The catalysts for policy tightening are a welcomed combination of growth and inflation, and indeed, while the policy is likely to become less accommodative, it is, nevertheless, still historically ultra-loose. Furthermore, massive debt levels will create a more cautious “policy normalization” as debt servicing burdens will force central banks to consider fiscal policy factors. Unfortunately, debt servicing costs will weigh disproportionally on weaker, more fiscally constrained economies, mainly in the developing world. As a result, the riskreward has shifted dramatically, making many emerging markets more vulnerable and less attractive.

How we’re responding

Indeed, the debt burden will weigh heavily on all, mainly the physically challenged countries and lower-quality companies. As monetary policy moves gradually back to some new “new normal”, shifts in yield curves coupled with our stronger dollar view will for sure be problematic for many.

In our portfolio strategy, we focus on quality. Regional allocation focuses on quality countries, countries with fiscal space, or key reserve currencies, primarily the USD and EURO. Similarly, at the asset class level, quality companies with already strong or improved balance sheets will manage more challenging monetary and fiscal conditions than companies of lesser quality.