Infection rates
We are encouraged by the global progress on Covid. The vaccine rollout has been a success, particularly in developed markets. Emerging markets have lagged on vaccination, but the recent surge in vaccine uptake in China is encouraging.Omicron, the latest Covid variant, has given reason for pause. Currently, infection rates of the variant are increasing globally, but the link between infections and hospitalizations appears to be weaker, based on what we know at this very early stage. Omicron is a reminder that the world is only as good as the weakest link the vaccination chain. This evident truth should concentrate the minds of global leaders in the year ahead and allow the continued re-opening of the global economy.
However, we are still unclear as to the long term implications of Covid, a topic discussed by Luke Bartholomew, Senior Economist, in his article Will the global economy suffer "economic long Covid"?
Inflation
Inflation continues to be a key theme and we believe rates will remain elevated into next year. However, there are signs that in the US, in particular, raw materials availability is improving, transport bottlenecks are opening up and shipping ports are now running 24/7.The inflation mathematics make it most likely that inflation will peak in the first or second quarter of 2022. Forecasts are now also factoring in a slightly greater "down-draft" from commodities and supply-chain issues easing.
The labor markets feel like the inflation battleground now. Will the millions who have exited the workforce return, fixing the supply side damage inflicted by Covid? Or will we see wage demands broaden away from sectors disrupted by Covid (or Brexit)? Inflation is quite plainly becoming a political as well as an economic problem, adding even more complexity to the mix.
With much to think about in this area, James McCann, Deputy Chief Economist, takes use through the inflation journey in 2022 in his article The inflation menace.
Interest rates
Our third ‘i’ is somewhat related to the second in that while investors are certainly watching inflation, central bankers are watching it with an even closer eye. US Federal Reserve (Fed) Chairman Jay Powell has recently been vocal in his reminders to investors of the Fed's inflationary concerns. These concerns have also been echoed at the Bank of England. Even the more optimistic forecasts for the path of inflation in the US and the UK have it persisting at levels that are likely to make central bankers somewhat nervous.While some of the interest-rate hiking that may be required is already reflected in market expectations, it is not hard to see scenarios where central banks may have to pursue policy that is less market-friendly.
What else will investors be keeping an eye on in 2022?
China
Chinese equity and bond markets endured further weakness and volatility at the end of the year thanks to additional regulatory interventions by the Chinese authorities, the deepening woes of the broader real estate sector and the drag from is zero-Covid strategy. While there appear to be some signs of redress appearing in the Chinese real estate market, it is clear that an adjustment of the real estate sector will not happen without an adjustment of the whole economy, given the scale and importance of the sector.This said, China’s economic growth will continue to outpace the global average, albeit not by the rate that we have become accustomed to. It also remains the home to many high-quality companies and a broad and deep bond market — both of which continue to offer opportunity.
In his article Asia’s attraction as bright as ever, James Thom, Senior Investment Director, Asian Equities takes us through some of these opportunities in Asia, and China in particular
Corporate investment
With the timing of tapering and policy-rate adjustment at the front of investors’ minds and the peak of the fiscal impulse having been seen, the private sector will need to pick up the growth baton. Company earnings have exceeded expectations by some way this year. Thus corporate liquidity is improving quickly, and survey evidence on investment intentions may presage further growth in activity. The rising price of labor, shortening supply chains and changing IT requirements may also prompt greater investment. While elements of this activity are in our central case for the year ahead, it is an area where one might look for upside surprise.In her article Corporate profits: speedy recovery? Karolina Noculak, Investment Director, Multi-Asset, develops this theme further and discusses the outlook for company earnings in 2022.
Emerging markets versus developed markets
The emerging market (EM) complex tends to be more sensitive to adverse moves in global interest rates and, unfortunately, as was noted above, their ability to respond to the Covid crisis has not been as effective as in most of the developed world. However more positively, EM central banks have been much quicker than their developed market peers to raise interest rates to try and dampen inflationary pressures. In addition, EMs, on many measures, offer value relative to many developed markets. This two-way pull between these arguments is likely to remain a feature in the year ahead,Technology
One of the heartening by-products of the global pandemic has been the speed of innovation by the many, many players in the technology sector and the much swifter adoption of new technology by individual and corporate customers. There is little doubt that the technology world we will see post Covid will be a very different one compared to the one we saw coming into it. This will provide huge investment opportunities, but could also threaten many of yesterday’s technology providers.Perhaps nowhere are the implications more wide-ranging than in the virtual worlds being created in the Metaverse. In her article Metaverse: what this Matrix fan learned about a real virtual world Pruksa Iamthongthong, Senior Investment Director, Asian Equities invites into this virtual world. Much of the hardware, software and infrastructure support required to build a fully virtual world where you can work, play, shop, just hang out, could come from emerging market companies, in Asia particularly.
What does this mean for markets in 2022?
The house view remains risk facing, but less so than when we entered into 2021. We would note a new phase in markets characterized by underlying growth peaking and slowing (but still above trend and with the likelihood of a near-term pick up in some key economies like the US and China as delta headwinds fade), sticky inflation (albeit, still expected to peak over the coming quarters and then moderate), tighter but still supportive liquidity conditions, and a better but still highly uncertain epidemiologic environment.
The risks around our central economic and policy mix are firmly tilted towards stronger short-term inflation, weaker growth and tighter policy — a combination that risk markets can potentially cope with, but nevertheless a less palatable cocktail than the one we saw at the start of 2021.
We see greater potential opportunity in equities than fixed income in 2022 and beyond. Among equities, we expect modest but positive returns in the year ahead supported by reasonable earnings growth and a continued low discount rate. As with 2021, we believe ongoing regional divergence to remain and have a preference for the US, quality and growth.
Mark Vincent, Global Head of Equity Research, gives us his view of the asset class in 2022 in this Global equities outlook.
In the bond markets, our view remains that real yields should be on a rising trend on a 12-month view — either driven by the solid recovery in the base line, central banks tightening policy more rapidly if inflation pressures do not cool sufficiently, or mechanically if negative demand shocks weigh on inflation. High yield continues to offer selective value — though the returns are rather meager relative to history and embed a (not unreasonable) assumption of a benign bad debt cycle.
In the Fixed income outlook, Nick Kordowski gives further color on the inflation arguments noted above, but also addresses a broader range of issues that may be important drivers of these markets in year ahead.
Omicron has been a reminder (as if any were needed) of the uncertain road that investors will have to navigate in 2022. As ever, this speaks to the potential benefits of well-diversified portfolios and careful security selection so that portfolios can cope with the expected — but perhaps more importantly, unexpected — bumps in the road.
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