29 October 2021

Outlook 2022: Growth and Opportunities as ESG Drives the Agenda


Outlook 2022: Growth and Opportunities as ESG Drives the Agenda


We discuss our outlook for the post-pandemic recovery, growth, and asset allocation, and why we expect ESG to dominate the agenda in 2022.

Imane Kabbaj

Welcome to PineBridge Investments podcast. My name is Imane Kabbaj, I'm the Sustainable Investment Specialist here at PineBridge. And I'm joined today by Markus Schomer, chief economist at PineBridge, and also by Hani Redha, portfolio manager in our multi asset team. In today’s podcast, we'll be looking at all the key themes to look out for in 2022.

Starting with ESG, climate change is obviously a no-brainer. As we're getting closer to COP26, there are quite a lot of expectations for all the world leaders to come up with concrete proposals to reach Net Zero. Regulation is also set to dominate the agenda for 2022.

Obviously, we will be leading the way with the SFDR and EU taxonomy. But there are also some expectations that other parts of the world will also come up with your own variation of various ESG rules and regulation.

And finally, 2022 will see the continuation of the rise in prominence of the “S“ element in ESG. So events in the past year, such as the pandemic, of course, BLM, the MeToo movement and all the various social unrests that we've witnessed around the world have shed the light on how ostracised some big portions of the society are.

All of these events have actually highlighted how important diversity and the reduction of inequalities in society are. So ESG is definitely going to be on top of the agenda for 2022. And we're also expected to see that for the upcoming years as well.

So talking about ESG, Hani as an asset allocator, how do you incorporate ESG into your investment process?

Hani Redha

Thank you, Imane.  I'd say over the last 18 months or so we've come a long way in terms of actually getting very granular and actually quantifying the impact of ESG at the asset class level, because up to now it seems that across the market, most people are really looking at a bottom-up, at the security level, what to exclude, what not to exclude, but at asset class level, I’m thinking about how ESG affects your asset allocation. That's uncharted territory, we've made progress with that.

I've actually published a very detailed report recently, which we're happy to share with clients going through about 50 different asset classes and sub asset classes and actually assessing these asset classes, in terms of their current state of being of ESG, the trend forward looking in ESG and also the level of engagement required, and very granular to the point that we're actually factoring in the impact these drivers will have on the valuation of asset classes. We do that through actual adjustments to the risk premia.

So lots of detail and granularity, which adds a lot more credibility to the whole process. So that's one major way that's happening. And then the other is that it's actually creating really interesting opportunities. In 2021, ESG related themes like renewables, as actual stocks actually have lagged, there are a lot of idiosyncratic reasons, we actually think 2022 looks very positive, particularly as we'll speak later, I'm sure about COP26 and the momentum that that can create. We find it to be quite positive for what we call “new energy” as a sub sector, which we put into our portfolios through the Productivity basket.

So that's a way for us to actually make money from ESG and actually benefit from investing and being aligned with this global theme. But on the global theme, Markus maybe you can come in here, and then give us a sense of from an economic perspective, how we are thinking about ESG in 2022.

Markus Schomer

First of all, from an ESG perspective, all three of these issues have always been integral parts of macro analysis, but the way they impact the economic outlook, I think are changing. And I think that's what makes it so interesting and so relevant for someone like me covering economics here at PineBridge. “E” in its environmental impact on the economy has always been more of a sort of an “unforcastable cyclical event” that hits economies, maybe in the form of hurricanes or earthquakes.

But I think where we are today with the research that's been done on climate change, the kind of modelling that's available, it becomes much more of a structural piece of the economic story, something that can actually be projected forward into the future and therefore incorporated into an economic outlook.

Similarly, you could argue that the “S” factor, obviously has always been important. But at least what we've seen in recent years is a greater volatility in terms of social issues that are reflected in greater volatility and greater fragmentation of politics. So outcomes of elections in many parts of the world are leading to wider swings of changes in economic policy. And I think the “s” factor is part of that increased fragmentation.

So it is clearly also something that economists are paying attention to, and I think it is becoming an ever more integral part of the outlook. And it's having an impact on the way we look at economic policy. For example, central banks around the world are increasingly looking at Green assets, as an example to include as part of their asset purchases.

Look at the Federal Reserve, it redefined what it believes its employment target is. Maximum employment always used to be the average unemployment rate. But now, the Federal Reserve is looking at a more gender and racial inclusive version of a definition for maximum employment. And here's another example how “s” is impacting economic policy, and of course, if you forecast central bank behaviour for the future, you have to take that into account.

Now, central banks are still facing other issues. Right now, it is the rise in inflation, which we believe will be largely transitory, but it's not just an issue that will be around for a few months, it probably will be here until the summer of 2022. So it will go deep into next year.

And central banks are facing a decision to, in some ways, abandon or diminish the support for that racial and gender inclusive employment target, as they turn their guns on inflation. So the confrontation of these two targets, I think will come to the fore again, in 2022. And I think it is one part of the outlook.

Another area where I think you'll see the impact is on fiscal policy. We've seen an unprecedented increase in fiscal stimulus in this recession, or rather, in this recovery, compared to previous ones, largely because that was the best way of dealing with the problem. We used fiscal policy to build an income bridge, as long as economies were closed because of the pandemic.

Now, as the economies are all reopening, we can withdraw that income bridge or diminish that income bridge, but other social and climate change related issues are increasingly coming to the fore front. And we will be using fiscal policy in these areas as well.

So I don't think that fiscal policy will dial back as much as it did, after the great financial market crisis when we, in many parts of the world went straight from stimulus to austerity. And that was one of the reasons why growth rates in many parts of the world were quite disappointing after the financial market crisis.

This time, that won't happen. I think fiscal policy will continue to remain an important policy tool that politicians will use, not to deal with a pandemic anymore, but to finance and accelerate the decarbonisation of the economies and just the transition to renewable energies, which is very, very hard to do without continued fiscal support from many governments around the world.

So there are many, many areas where ESG is impacting not just the longer term thinking, but also, in fact, the near term outlook for next year, in the sense that central banks will continue to look at Green projects, for example, health financing there and fiscal policy will be utilised to bring about some of these major changes that I think are needed to achieve the targets that governments have been setting themselves.

Imane Kabbaj

That’s very true Markus. If we look into the US, there is quite a stark contrast in terms of the Biden administration versus the previous administration of Mr. Trump in regards to climate change. So we see some early signs of how important climate change is going to be in the US, not only from an economic perspective, but then also from a regulatory perspective.

As we all know, Mr. Biden is a keen supporter of climate change policies and then also attaining the Net Zero objectives, and one of his first sort of acts or decisions as a President was the executive order that he passed a few months ago in regard to the incorporation of climate related financial risks. And this actually has recently materialised by the Department of Labour, putting together a proposed rules to incorporate ESG disclosures as part of the fiduciary duty for American pension funds.

This is still a proposed rule, it will be discussed in the next few months. And then we'll find out more about this and how it will be implemented, but very, very encouraging signs coming from the US about the importance of climate and climate related issues, and how they will be incorporated from a regulatory perspective.

Now, of course, when it comes to ESG regulation, we have different sides of the spectrum across the globe. So, it is very much at the nascent stage in the US, if we look into Asia, it is very much a gathering pace. So of course, there is not a single pace. In Asia, various countries are doing different things at different paces. But if we look at, for example, the monetary authority in Singapore, they have recently issued some guidelines about ESG risks.

If we look at the SFC in Hong Kong, they're putting forward a policy around the enhancements of ESG disclosures and ESG funds, and other regulators in Asia are also coming up with their own rules. So we see quite a lot of movements coming out from there in terms of regulations, and it will only continue to gather pace.

If we look at Europe, which is traditionally the most advanced region in the world when it comes to climate related issues either from an economic perspective or from  regulation. Obviously SFDR is leading the path when it comes to ESG regulation. So we have SFDR and the EU taxonomy that are scheduled to be implemented starting in 2022.

And we very much believe that they will be used as a framework globally further down the line by other jurisdictions and other parts of the world. And incidentally, the UK has also recently published a trademark for sustainability disclosures. There are a few similarities with the SFDR and the EU taxonomy. Of course, this is still very early stages.

We'll know more about this once the consultation is published in November of this year but again, very, very encouraging signs coming from Europe. And still staying within the UK at the time of this recording COP26 is very much around the corner. And it's definitely going to be the big event either for this year or for next year when it comes to climate change.

So still a lot of expectations from the world leaders to come up with concrete solutions and concrete plans about how we are going to decarbonize the economy and how we're going to reach Net Zero. So we are definitely going to keep an eye on that and then making sure that we can close in detail at the suggested strategies and the successive action points.

But there are a few things to look out for within COP26, it is not only the concrete plans when it comes to decarbonisation, but the race to Net Zero is not going to be achieved unless we look at it from a global sovereign level. And this is where the NDC, the National Defined Contributions come into place.

So as of end of October, there is still quite a lot of countries that have yet to submit their NDCs contributions. Now we're talking at countries about some G 20 countries like Australia, Saudi Arabia, Russia, China, of course that have yet to publicly submit their pledges towards climate change.

And it's very important to have all of these key countries not only from a G20 perspective on boards, as it will otherwise be very difficult to reach Net Zero. And at this stage of the recording, we're still unsure whether or not big players in climate change normally because they are the biggest emitters of co2, but they're also some of the biggest producers of fossil fuels like China and Russia, we're still unsure whether or not their respective presidents will be attending COP26. And that will send quite a lot strong signal because it will be near impossible to reach climate change goals if we do not have these countries on board.

Hani Redha

Well, you know, you mentioned COP26 and China. I think there's still anxiety at the time of this recording about whether they'll show up or what kind of commitments we'll see there. But to us, it's not really a big surprise, because there are some tectonic strategic shifts happening in China right now on a very broad basis.

And you can actually look at it from an ESG lens in the sense that there's a real focus on addressing inequality, and trying to restructure the economy to have more inclusive growth. And it may well in the medium to longer term result in a more sustainable growth model.

But in the near term, and looking to 2022, you know, we're still quite concerned about the drag on growth from China, and on economies and countries that are closely linked to China and dependent on Chinese demand. And so in our portfolios, you know, we've been very cautious on emerging market exposure within equities, preferring to play it through fixed income.

So we see this drag from China continuing, and that's going to be one of the important themes in our outlook for 2022. But if we step back a bit Markus, for the developed markets, what do you see as the path of growth in 2022?

Markus Schomer

China's playing an important role in the outlook for the global economy, obviously, but China's role is a little bit different this time, after the great financial market crisis, it was China, and the enormous amount of debt financed stimulus spending that essentially pulled the rest of the world out of the economic recession.

The Europeans and the US very quickly went from fiscal stimulus to fiscal austerity. But China continued to finance infrastructure spending, and other government supported outlays through an enormous build-up in government and quasi government debt. And that was an enormous stimulus not just for China itself but for the rest of the world, in particular, for emerging markets and commodity producers.

This time, the roles are almost reversed, China's stimulus measures have been quite disappointing. And the economy is actually not showing a lot of momentum right now, where the stimulus has been the most powerful this time around, has been in the US and it is really, almost a mirror image.

In the US, we've now seen a massive expansion in government debt to finance, partly infrastructure, but maybe more so income related stimulus measures that are related to the closure of the economies in response to COVID. But fiscal policy is not turning off so quickly. And what is being debated right now in the US, is another round of fiscal spending, that is partly related to more income support, but also starting to focus on infrastructure.

And in that regard, it is somewhat similar to what China did in the 2010’s. America is playing that role in the 2020’s. So the more vigorous growth prospects for 2022, we believe will still be found in the US and that is the economy to keep an eye on in order to get global growth rate.

The Europeans are somewhat in between, the stimulus measures there have been equally powerful to what we've seen in the US to a large degree. And the fact that for the first time, we actually now have an EU wide fiscal support package that will be financed by EU issued debt and not just financed by the individual countries anymore, is a major step towards a fiscal union.

They are probably still quite a bit away from the establishment of such a more centralised, EU-wide fiscal policy. But clearly the first step has been done and in a sense, I think it is a very important development that will continue to help stimulate growth in many parts of the EU, in particular, because it's somewhat asymmetric in its payout. Countries that require more stimulus because they have for example, higher unemployment rates, will receive more of that package and countries that already are further ahead  in the recovery and don't require as much stimulus will receive less, whereas the financing will be done according to the GDP weights in the EU.

It is not as large as it is in the US, at least what is debated in the US. But it is also not like the last business cycle where the fiscal stimulus in the EU very, very quickly went away and we ended up in a debt crisis that led to very sharp fiscal austerity, that is not on the cards this time. So the roles are a little bit reversed. The US is really powering ahead with this stimulus driven recovery. The Europeans benefit from that as a region with a very large trade surplus. The Chinese are not imparting the same kind of stimulus on the rest of the world, which is also the reason why so far, the recovery really has been a developed world recovery and not so much an emerging markets recovery. Emerging markets are more tied to the lack of stimulus in China.

But the economy in China will continue to produce very good growth rates. This is the challenge to differentiate between the level of growth and the change in growth rates. The Chinese economy has already settled back at a more natural pace of economic growth, whereas in many other parts of the world, we're still in a sort of post peak recovery period, I would say, where growth are still significantly above long term averages.

And that to me is also really what characterises 2022. It will be a year where global growth will be lower than it was in 2021. But then 2021 was a very exceptional year, we shouldn't forget that. But growth rates in 2022 will continue to be above long term averages. So they will be above the underlying growth potential of the world.

And in that kind of environment, you will continue to see unemployment rates decline, you will continue to see output gaps being closed. And that is typically a world where growth assets do well. This is not a world where we're slipping below the growth potential and we open up a demand problem. That's not the world we foresee in 2022. That may come a little bit later in this cycle, when central banks may start to more aggressively raise interest rates. But that's not the story for 2022.

We believe that monetary policy will continue to be stimulative. Some central banks have started to raise interest rates, but apart from that, any of the big central banks will be getting there in 2022.

Yes, QE will likely end in many parts of the world. So the support for financial markets will be withdrawn. But the support for the economy that comes from low interest rates will continue to be there through most of 2022.

Well, thank you Imane and Hani for a stimulating conversation. We covered a lot of ground there. But the key things for me were that ESG would dominate the agenda in the next few years. And COP26 will set the tone for what actions will be implemented. So this is the space to watch.

The post-pandemic recovery so far has been very much a DM recovery, which is why we've been more cautious on EM exposure within equities, preferring to play through emerging market fixed income. But overall, just the growth rates will still remain very supportive for risk assets. And the growth outlook will remain strong in 2022.

The key challenge is the beginning of normalisation in fiscal and monetary policy after two years extraordinary stimulus from both. That's going to be the challenge for growth overall, but also the challenge for financial markets.

I hope we've left you all with a few ideas on what to expect in 2022. Maybe even with a desire to dig in a little bit deeper into the subjects that we've covered. If so, you'll find more information on those subjects we've covered under investment that and economic insights on our website pinebridge.com.

So thank you very much for listening. And we hope you'll join us for our next podcast in mid November, where we will cover the key takeaways from COP26.


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