We were planning to run this article in the week before Christmas, but the top risk on our list is now manifesting itself early. We have decided to run this article early in case any more of the risks on our list consolidate in the next few weeks!
It is important to note that these are risks which we think will have an impact on markets, or parts of them, if they occur next year. They are something investors need to be aware of and ideally prepare for if they can.
#1. COVID 19 mutation
We are listing these in order of both magnitude and sadly likelihood. We have been expecting a COVID mutation “of concern” for quite some time, so the advent of Omicron in southern Africa comes as no surprise. The fact that many developed world countries are moving on to vaccine booster shots while millions of Africans still have no access to vaccines is creating scope for yet further mutations in countries where the vaccine program is slow.
“The Covid-19 virus isn’t going anywhere anytime soon and will continue to mutate until we’ve run out of Greek letters,” said Barclay Pearce Capital in an investor note today. “Given the history of virus mutation, it is highly unlikely that the virus will alter itself significantly to alter the efficacy of vaccines currently available. It appears the biggest risk to financial markets is not the virus but government reactions to the virus but given the lockdown-fatigue experienced by citizens around the world, there would need to be compelling evidence for governments to restart lockdowns and close international borders again.”
Regardless, governments will tend to err on the side of caution here, and the virus will continue to mutate in 2022. While there was something of a post-COVID atmosphere settling in on the streets of London in November, it is obvious the relaxation is going to be a short-lived phenomenon.
Before COVID reared its ugly head again, investors were far more concerned about the spectre of inflation in 2022. This was starting to manifest itself in the almost hysterical coverage of the Fed in the financial media. Markets are concerned about when central banks will start withdrawing support for businesses and raising interest rates. The problem is they cannot let inflation run for ever, and rates in many developed countries are already starting to look punishing.
“Certainly, hyperinflation of immense proportions can have a devastating impact on an economy, as we’ve recently seen with Zimbabwe and Venezuela,” said Mati Greenspan, founder of Quantum Economics. “However, there are far more examples of countries that have lived with high levels of inflation for many years and have yet to fall off the planet. My sneaking suspicion is that most would probably not list inflation as their number one problem right now. It’s more like a symptom.”
Inflation is going to also hit equities, so investors beware. Take United Utilities (LSE:UU) for example: the company reported recently that inflation had caused its core costs to rise, and a portion of its debt is also linked to inflation. It has been enough to put the group’s bottom line in the red. Many are predicting that inflation rises are just a short term blip of course, but how deep into 2022 will this ‘blip’ last?
#3. European energy crisis
Natural gas prices have been heading upwards for some time now and we flagged gas as the long commodities trade for 2021 back in the summer. There has obviously been some serious disruption to both the US and European gas markets and to be honest you cannot level most of the blame at COVID this time. As we go into the winter, UK electricity prices are also riding high and the cost of heating a home is considerably higher than it was in 2020. The situation is also leading directly to the collapse of smaller energy suppliers like the UK’s Bulb Energy.
“The collapse of Bulb Energy is the latest indicator of the difficulties faced by the UK energy retail industry,” said Allegra Dawes, an analyst with Third Bridge. “Since August, more than 10 energy suppliers have collapsed and our experts expect that by year-end, the market will be down to around 10 big players with only a handful of smaller players remaining. While current wholesale prices have challenged all utility providers, Bulb’s acquisition of customers on zero to negative margins was a particular risk to the company even prior to their collapse.”
The energy sector is going to be an especially risky place to be for smaller companies in 2022, unless you are a producer. However increased energy costs will also feed into corporate profits – a higher oil price is also going to make life tougher for the likes of the transport sector. Most companies also consume electricity and will feel the pinch.
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#4. Cryptocurrency regulation drive
Cryptocurrencies are still heavily reliant on news flow for price action. While the SEC approval of crypto ETFs was a big boost for Bitcoin, China’s decision to make Bitcoin mining illegal in the country took the wind out of the sails of the last big Bitcoin rally. Further international moves to rein in cryptocurrency could put a dent in Bitcoin and Ethereum prices in the New Year. Most experts in the sector anticipate that there will be further regulation on the cards in 2022 and that the main cryptocurrency trading platforms will be where regulators start.
“It’s still the Wild West, as the SEC’s Gary Gensler put it,” commented Neil Wilson, Chief Market Analyst with Markets.com. “The fact is, fake/dodgy coins can moon and become worth a lot more than actual, serious DeFi projects built on years of proper research, which is kind of crazy. Who’s next? Some point to something like Shiba Inu, the self-declared Doge killer had a tremendous October, rising over 700% for the month. Memecoins are now a problem. And even if it’s not a scam, we all know any crypto can fall just as quickly as it will rise.”
It is likely to be this rougher end of the market that regulators will focus on. We have seen a number of frauds coming out of this space in 2021, along with altcoins that, while well-intentioned, should simply not be the custodians of investor money. Two guys in a basement with a computer are not a currency or even a bank. Regulators will likely seeks to focus on entry points and try to sort the wheat – regulated cryptocurrency platforms – from the chaff (dodgy brokerages in Vanuatu and Panama). But substantial moves to regulate or even ban cryptocurrencies will impact prices immediately. Much of course depends on what proposed regulatory regimes look like.
#5. Great military power contest
This final risk is the least likely in our view, but it is now more of a risk than it was two years ago, and so we are flagging it up on our list. While there is once again a rising chance of some kind of military action against Iran, this has been on the cards for years now, and waxes and wanes like the moon over Tehran. Our main concerns centre on Russia and China.
China has been working towards some form of projected military supremacy in the South China Sea and indeed in its immediate territorial waters. Most of its military spend program seems to be devoted towards the ability to protect its coasts from foreign military operations. Its prime military project, we feel, is the recovery of Taiwan, and this year we have seen China regularly testing Taiwan’s air defences with incursions with its jets. For China, Taiwan is unfinished business, and while previous leadership in Beijing (e.g. Hu Jintao/Jiang Zemin) seem to have invested their hopes in diplomacy, we are not so sure about Xi Jinping.
The other major concern is Russia and Ukraine. As with Taiwan and China, Ukraine is still unfinished business for Russia. Vladimir Putin tested the US and EU when he occupied Crimea in 2014. Since then, Russia-backed militias have posed the primary security threat in Ukraine, but more recently Russia has taken to massing substantial military power on Ukraine’s eastern border. In addition there have been rumours this month of a coup plot in Ukraine. Prior to the Orange Revolution of 2005, Russia could work through relatively friendly leaderships in Kiev, but since then has been concerned about growing EU and NATO influence over the country.