Outlook for 2022
Many of the same factors and forces witnessed in 2021 are likely to influence markets in the coming year.
- The Covid pandemic is not over, as evidenced by the emergence and rapid spread of the new Omicron variant. Austria is coming to the end of a three-week lockdown, many other countries in Europe have re-introduced restrictions and England has just moved to ‘Plan B’, which includes guidance to work-from-home and makes facemasks mandatory again in most indoor public places. Countries will revert to full lockdowns only as a last resort but the possibility that the virus, or new vaccine-resistant variants of it, could wreak further damage on economies and corporate profits cannot be ignored.
- The tapering and then the end of quantitative easing is in prospect for 2022 raising the question of the impact this will this have on bond markets whose repressed yields have long supported equity market valuations. In addition, soaring rates of inflation make the continuation of negligible and negative interest rates more and more untenable. Financial markets have operated in an environment of ultra-low bond yields and interest rates since the end of the Global Financial Crisis in 2009 and the transition to higher rates, if it comes, could be challenging.
- Inflation is, of course, the biggest determinant of the likely path of interest rates in 2022. For most of 2021, central banks maintained that the upward trend was ‘transitory’, caused by an unsustainable explosion in demand following the end of lockdowns which had temporarily overwhelmed supply chains. With every new data point that emerges, however, that argument is undermined and it is interesting that the Federal Reserve has recently decided to ‘retire’ the word from its messaging. We think that inflation rates could spike even higher in the short term before settling lower than they are at present, albeit at above the 2% level targeted by both the Bank of England and the Federal Reserve.
- We are fairly sanguine about the prospects for economic growth in 2022, expecting it to moderate from 2021’s rebound level but still be solid. As always, however, there are risks and amongst them we would cite a resurgence of the pandemic, a squeeze on consumer spending caused by higher inflation and, in the UK, higher taxes, or an exogenous event, such a property-related financial shock in China or military conflict.
In our opinion, the biggest risk to financial markets in 2022 is policy error by central banks. Do nothing or too little and the inflation genie might well and truly escape its bottle. However, excessive tightening of monetary policy could turn a slowdown in economic growth into a recession and also expose the high levels of debt embedded in the financial system. It is an exceptionally difficult balance to get right.
Not for the first time, we remind investors that returns from equity markets in 2021 (and indeed since the Global Financial Crisis) have been exceptional and are almost certainly not sustainable. Indeed, because of very low yields in bond markets and lofty valuations in stock markets, investors with balanced portfolios should not expect returns of more 4% p.a. over the next 10-15 years. We also expect financial markets to exhibit higher volatility as more than a decade of unprecedented monetary support comes to an end.
Summary
Given the uncertainties, 2022 is not a year for taking big bets on asset allocation, geography or investment style.
Against our most likely backdrop of robust economic growth, lingering inflation and the winding down of quantitative easing, we expect bond yields to trend higher in 2022.
Equity market valuations remain extremely high on any historical basis. However, with interest rates so negative in real terms (interest rates less inflation rates), and likely to remain so, we acknowledge that high valuations may persist. We expect corporate profits to be the main driver of share prices in 2022 and good stock selection will therefore be vital.
