- Equity returns will be more muted, but still positive, in 2022, supported by solid corporate earnings.
- Inflation remains a concern and will put pressure on central banks to start to raise rates.
- The latest Covid-19 variant – Omicron – is already leading to partial lockdowns, which could lead to slower growth at the start of 2022.
Fund managers tend to have a fairly miserable disposition because, even when performance is strong, you inevitably worry about how you are going to generate returns in the future. After such a strong year for markets, this concern is even more pronounced. Last year, the vaccine announcements inspired confidence in a "reopening trade" which offered high returns with limited risks.
Looking at our models, we are now entering a more mature phase of the economic cycle when growth momentum peaks and central banks begin to withdraw support. Against this backdrop, we expect equity returns to be more muted but still positive, supported by solid corporate earnings.
What are the key risks to this view?
Inflation is a popular theme, and we would agree that over the medium term we are likely to be in a more inflationary environment compared to the last decade, driven by rising wages, deglobalisation and decarbonisation. In the shorter term we expect inflation momentum to peak as supply bottlenecks ease, but central banks are still likely to raise interest rates.
At stock level, it is important to identify those companies with pricing power given the risk to profit margins that higher input costs and wages pose, as these will be better placed to weather the storm. However, we do not believe that inflation poses a systemic risk for markets yet as the willingness of central banks to start raising rates in response to inflationary pressures should keep inflation expectations in check.
The Omicron variant of Covid-19 remains a concern
Covid-19 continues to cause volatility, with the latest variant, Omicron, renewing these concerns. It is important to step back and acknowledge that we've come a long way since the first quarter of 2020. Levels of immunity are considerably higher, even in the face of mutations; governments have become more experienced and react more quickly; and the processes of how to develop new vaccines are increasingly efficient and streamlined. Market participants have also developed a framework to consider the virus.
We have moved on significantly from the extreme uncertainty of early 2020. Nevertheless, early indications suggest that Omicron can evade some of the protection afforded by vaccines, which is already leading to partial lockdowns. It'll be a slow start to the year in terms of growth.
In an ideal world, we would be seeing a strong synchronised global economic recovery which would allow us to rotate into more cyclical and cheaper exposures. The onset of Omicron makes this less likely.
The one area that could surprise is China where, unlike other major economies, policy is turning stimulative.
Opportunities remain, but we mustn’t over-steer
Our biggest concern is that we are having to favour trends which are old and rather tired, and in danger of exhaustion: US exceptionalism (the idea that the US is seen, both domestically and internationally, as superior to other nations) and the unrelenting search for yield.
Given our expectation that any rise in bond yields will be contained, we think it is too early to take advantage of mean reversion opportunities, as juicy as they may seem, and we must resist the temptation to over-steer.
As fiscal support is reined in, the private sector will have to take on the baton of growth
In recent years, we compared the global economy to a "wobbly bicycle", where a lack of economic momentum left us vulnerable to being blown off course by any gust of wind. The pandemic forced governments to put stabilisers on the wobbly bicycle, allowing us some reprieve from cyclical volatility. Those stabilisers will be coming off in 2022 and the private sector will have to take on the baton of growth.
My more technical colleagues would describe the potential distribution of outcomes as “platykurtic”, a more muted upside with elevated risks. In more simple terms, diversify your risk - this is not a time for big bets.
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