Investment Strategy

Five key questions for investors in 2022

The world economy is continuing to recover from the disruption caused by the pandemic, setting the scene for another year of attractive returns from selective regions and asset classes.

As we continue to navigate the mid-cycle, some key macroeconomic dynamics to watch include the moderation in growth and investment returns, high inflation and rising interest rates, especially in the U.S. and other developed markets (DMs). Asia’s policymakers may turn more supportive and supply chain issues could ease. Risks include inflation remaining higher for longer, new coronavirus variants and geopolitical tensions. Following are five key questions investors are likely to face in 2022.

While growth is moderating from the post-pandemic peak, we think it will remain above its long-term average for two reasons. First, strong consumer spending in DMs is likely to sustain a decent pace of economic growth. Cumulative household savings at the end of 2020 were well above the pre-COVID trend and continued to increase last year.

Second, cash-rich corporate balance sheets could fuel a strong investment cycle. U.S. profits are at all-time highs. With strong global demand and low inventories, corporates could begin to reinvest their profits and we except the cycle to remain strong.

Against this backdrop of strong growth, we expect inflation to remain high and peak by mid-year, before falling to slightly above the Fed’s 2% target by the end of 2022. Yet we do not think inflation will remain high enough for the Fed to hike more than the market expects for two reasons.

First, we expect goods inflation will still be driven by a few sectors like autos, primarily as a result of pandemic-driven supply disruptions. In our view, these price increases are unsustainable and likely to fall.

Second, there are fears that we could see a wage-price spiral driven by labor shortages, resulting in inflation that becomes unanchored. Many are pointing to the ‘Great Resignation’ and claim we are facing a new labor market regime – but we disagree.

We expect the Fed to tighten policy in line with expectations, with three rate hikes this year and three next year. With a tighter Fed already being priced into markets and yields having repriced upwards so far this year, we think markets have already digested a lot of this shift. However, we believe yields could continue to climb higher, keeping the pressure on high-multiple growth stocks and supporting our preference for higher-quality names.

While we have seen a sharp repricing in rates recently, another factor we are scrutinizing is real interest rates, which are likely to remain low and accommodative. Even with rate hikes this year and next, with inflation above trend, real interest rates will rise (they already have) but still remain relatively low, which is supportive for financial conditions and growth.

After the latest Fed communication, a key question would be how it handles its balance sheet, and if we could see a quick transition from quantitative easing to tightening. This potential for policy volatility is one of the key reasons for our recommendation to diversify portfolios and invest actively. In periods of policy tightening and rising rates, sector dispersion tends to increase, favoring active allocation.

China is facing growth pressures from a slowing property sector and the negative impact of economic restrictions in pursuit of ‘zero COVID’. As sales numbers slow, construction and investment are also weakening. Measures to control COVID are having slowing consumption and economic activity, and the potential for recurring outbreaks and restrictions remains high.

Policy has shifted to being more supportive. We expect further easing but not the same flood of credit as we have seen in past slowdowns. In terms of credit growth, the trend of policy tightening has reversed. However, China’s growth priorities and policies have changed, and it can no longer afford such a large increase in debt. We expect further monetary and fiscal stimulus to cushion the downturn, but not substantially reverse the growth trend.

What does this mean for the rest of the world? Over the past two years, most DMs have not relied on China as much for growth. Despite China’s slowdown, we saw some of the strongest growth numbers in DMs for many years. However, for emerging markets (EMs), particularly commodity exporters, the story is different. A slowing and rebalancing China carries a substantial risk.

The historical correlation between EM assets and commodities is a reason for caution. In addition to China, EMs have already started to tighten policy and face a more difficult path out of the pandemic. For these reasons, we are more positive on the outlook for DMs.

Supply chains are critical for both growth and inflation, and the disruption has persisted longer than expected. Yet recent data suggests pressures may have peaked and might start to moderate.

We see a silver lining. With supply chains strained, demand still strong and inventories depleted, we are starting to see an investment response. Corporate capex is picking up and we are at the beginning of what could be a strong cycle.

This phenomenon is not just taking place in the U.S., but in Asia too. Strong exports are sparking an increase in investment into additional production and supply, driving the quickest capex rebound in a post-crisis environment. This important trend is a reason why we think this recovery could be strong and persist for a longer time, even as consumption moderates.

While our outlook is optimistic, three risks could cause markets to become more volatile:

  • If inflation continues to surprise to the upside, it could result in a much more aggressive policy shift from the Fed, which would be unsettling for economic growth and financial markets.
  • Supply chains problems in 2021 were exacerbated by outbreaks and restrictions in Asia’s key manufacturing economies. New coronavirus variants and the continued economic impact from mobility restrictions remain a risk.
  • Potential sources of geopolitical stress include Russia–Ukraine tensions, U.S.–China tensions, Iran’s nuclear program and the U.S. midterm elections. They could add to an already volatile environment, underscoring the need for diversification and active management in portfolios.

If you’d like to find out more about our views for the year ahead, you can listen to a replay of our 2022 Outlook. We explore a wide range of issues from how to position portfolios for the long term to investing in the fight against climate change.

The MSCI Emerging Markets Index captures large and mid cap representation across 23 Emerging Markets (EM) countries. With 834 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

Bloomberg Finance L.P. Commodity Index is a benchmark designed to provide liquid and diversified exposure to physical commodities via futures contracts.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

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