Chris IggoAXA IM Chief Investment Officer, Core Investments
January 25, 2022
Investing in 2022: Four key market drivers
Looking ahead into 2022, further surprises – as well as challenges and opportunities - will present themselves. We look at some of the key issues investors will need to navigate over the coming 12 months. The potential end of the pandemic, higher inflation, a tighter monetary environment and an intensified focus on achieving net-zero carbon will be the dominating themes.
7 minutes
Original Content: AXA IM
The pandemic and rising inflation were prevailing drivers of markets in 2021. But the economic squeeze which dominated 2020 finally started to loosen its grip, as the world started to get back to something resembling ‘normality’ in the second half of last year.
The global economy endured a severe contraction in 2020, where real global GDP retreated by 3.2%. But because of the vaccine rollout, which allowed shuttered nations to emerge from their prolonged lockdowns, last year staged a significant comeback – and we currently estimate global growth of 5.7% in 2021 and forecast 4.2% for 2022.1
Equally, equity markets - despite the uncertain backdrop - continued to deliver above-average returns, with shares globally up 22% over the year – surpassing 2021’s 16%.2
Fixed income returns were covered in less glory however, with government bonds down 7% - although global high yield managed to eke out a more respectable 1% gain - as a result of rapidly rising inflation and subsequent concerns over tighter monetary policy.3
Beyond COVID-19, it was an eventful year of many highs and lows. Investors witnessed the rise of the ‘meme stock’, most notably in the case of the US video game retailer GameStop, which saw its value soar by some 1,700% in the space of a month.4
Elsewhere bitcoin hit an all-time high, while the People’s Bank of China delivered a major cash injection into the banking system in a bid to prop up the property sector, after one of the country’s biggest - and heavily indebted developers - Evergrande found itself in hot water. Yet the big picture was of a world growing strongly as it increasingly found ways to deal with COVID-19. Growth came back, but with that came some other issues.
Looking ahead into 2022, further surprises – as well as challenges and opportunities - will present themselves. We look at some of the key issues investors will need to navigate over the coming 12 months. The potential end of the pandemic, higher inflation, a tighter monetary environment and an intensified focus on achieving net-zero carbon will be the dominating themes.
Omicron – the beginning of the end for COVID-19?
Now two years into the crisis, recently there has been much debate over whether the end of the pandemic is in sight – the Omicron variant, while highly transmissible, appears to have a milder impact on those it infects. But while the World Health Organization has cautioned that it is too soon to be treating COVID-19 as an endemic illness like the flu, several studies have concluded that the risk of hospitalisation from Omicron is lower than from Delta - and recent data supports that proposition.5
However what is beyond doubt is that the virus is still a key source for concern for investors and retains the ability to significantly influence and disrupt demand and supply, and hence market behaviour.
The continued rollout of vaccines worldwide is vital – especially in many developing markets which have been beleaguered by vaccine shortages. The existence of the virus remains a feature of everyday life at the beginning of 2022 and obviously is preventing a complete return to the kind of normality that prevailed before January 2020. However, the end may be in sight and that is good news for the economic outlook and for investors.
The inflation factor
Inflation has been a challenge for central bankers for years, albeit in terms of trying to coax it higher. But following a post-lockdown boom of rising demand, policymakers are faced with having to reduce it, after the cost of living surged in the latter half of the year. December data shows prices in the US are growing at their fastest pace in almost four decades, with inflation up 7% year-on-year.6
At present we believe inflation is likely to start to ease back as 2022 progresses. To date, this view, shared by the market, has held back a significant increase in long-term bond yields - although yields are now rising. Several major central banks will likely start to increase policy rates from their pandemic crisis levels over the next year or so. Anticipating these shifts in the monetary policy stance created some market volatility at the beginning of 2022 with both bond and equity markets struggling.
However, this year, investors need to examine several factors over the likely direction of inflation; will central banks need to do more than expected, i.e. what is priced in? And should investors adapt their portfolios to shield themselves from an unexpected or sub-optimal outcome? Some assets have already done better in this higher inflation environment.
The most notable, if not the most surprising, have been inflation-linked bonds. In the near term, markets are adapting to the reality of higher inflation and the higher interest rates that will bring. But much is already priced in and once a new ‘equilibrium’ expectation has been met, volatility could again subside, helping investment returns.
Monetary policy tightens
In the wake of higher inflation, interest rates will need to go up. These moves are starting from very low levels and would likely be limited by historical standards; however, what is perhaps more certain is that the era of pandemic-crisis monetary policy is coming to an end.
We’ve already witnessed hikes in New Zealand, Poland, Norway, South Korea, the Czech Republic and most recently in the UK as central banks begin to unwind emergency measures put in place during the pandemic. But higher borrowing costs will have very different implications for bond and equity market returns - and economic growth.
Markets have been pricing in these hikes, and the rapid rise in inflation has fuelled these expectations and allowed them to become dislodged from the prevailing forward guidance that central bankers had used as one of their post-crisis monetary policy tools.
If monetary support is removed too rapidly, the business cycle becomes shorter, which in turn would lead to a slowdown in growth. The extent to which this could happen really depends on the path of inflation. For now, however, central banks will err on the side of caution and will need to be convinced that the long period of low inflation is coming to an end.
Presently the market is pricing in that it will take the US Federal Reserve over a year to fully reverse the cuts in interest rates that took place in as little of two weeks back in March 2020. Monetary tightening can be fairly gradual. In the meantime, investors should still enjoy decent returns as companies continue to respond to structural forces like digitalisation and the energy transition.
Climate transition
This year should see a further acceleration of the transition to a low-carbon world. COP26 garnered some lukewarm reviews – and certainly a long and arduous journey lays ahead in terms of delivering net zero by 2050 – but I am more optimistic for the future.
The Glasgow Climate Pact will drive the pace of climate action as nations now need to deliver new Nationally Defined Contributions (NDCs) to decarbonisation, with a focus on 2030, by the time of the next COP in Sharm El-Sheikh at the end of next year. Prior to the Glasgow gathering, the next publication of NDCs was due in 2025.7
Investors want to see change and the shift to a carbon-neutral world will bring with in plenty of opportunities - the progress towards decarbonisation will increasingly determine capital allocation and investors are playing a key role in supporting this.
A cursory glance at fund sales in 2021 starkly highlights this point as a record US$649bn flowed into environmental, social and governance (ESG) focused portfolios worldwide (to end of November) – a significant rise on the $542bn and $285bn which flowed into such strategies during 2020 and 2019 respectively, according to Refinitiv Lipper data.8
Reducing climate change risks in portfolios and seeking opportunities in the businesses and technologies that are leading the energy transition will be an overarching theme for 2022.
An optimistic investment backdrop
The good news in the outlook is that we can see the light at the end of the tunnel as far as the COVID-19 pandemic goes. Travel and social activity can normalise as a result and this will bring many economic benefits. Moreover, the need to re-vitalise businesses and re-purpose supply chains will give a boost to activity, as will the ongoing pursuit of more sustainable business models. The corporate sector is healthy with profits growing at a decent clip and the household sector is benefitting from strong job and wage growth.
Global monetary conditions will tighten but, for this year at least, we are not even getting back to the immediate pre-pandemic level of interest rates. In my mind that is not enough to derail the business cycle. The start of the year is proving challenging as markets anticipate where interest rates are going, but global earnings per share will grow again this year, companies will continue to be innovative and consumers still have some catching up to do in terms of spending – especially on things like holidays and hospitality. There are reasons to be optimistic for 2022 even if January is proving to be somewhat testing.
