Slowing down, but still on track

4 min read 11 Jan 22

Summary: Despite a challenging start to December, equity markets enjoyed strong gains in the month to round out another positive year for risk assets. Investors carried lingering COVID-19 and inflation concerns into the new year, with attention turning to the pace of monetary policy tightening. Despite slowing growth, the recovery remains on track. Investment Specialist, Kirsty Clark reviews recent market performance and the risks contributing to rising uncertainty in 2022.

It was a challenging start to December, as ongoing fears over the impact of the COVID-19 ‘Omicron’ variant paired with lingering inflation concerns and increasingly hawkish tones from central banks to subdue risk appetite. However, as sentiment improved, equity markets rallied in the second half to finish the month in positive territory. The MSCI AC World Index ended the month up 4% (total returns in US dollar terms), and was up ca. 19% over the year as a whole.

Investors rotated into more defensive areas of the market, boosting utilities and consumer staples names in particular. Consumer discretionary stocks were the laggards in December, with the global sector finishing the month down. Industries with greater exposure to the reopening trade, including retailers and autos, also lost ground, but the latter was among the strongest gainers over the year, along with energy and information technology. Value outperformed Growth, and large caps pulled ahead of their small cap counterparts.

Regionally, the UK (FTSE 100) and Europe (DAX 30, EUROSTOXX) led the equity market gains, as more encouraging data on the ‘Omicron’ variant, a surprise UK rate rise and announced tapering from the ECB saw banks, industrials and materials bounce back. All major regions benefited from the year-end rally and secured positive returns in December. Relative laggards included Emerging Markets, Asia and Japan. Despite middling returns in December, US equities were the standout performers in 2021, delivering 20-30% total returns over the year. 

With evidence of more persistent inflationary pressures, a speedier trajectory for winding down central bank asset purchases and ramping up rate rises weighed on bond markets. Developed market government bonds lost ground in December, extending the challenging performance over the year. UK gilts were among the weakest performers over both periods. EM sovereigns finished the year on a strong note but lost ground overall in 2021. Investment grade had a fairly lacklustre month while global high yield fared a little better, securing positive returns in December and finishing 2021 up. In commodities, Brent crude was again top of the leaders board as supply struggled to meet growing demand. Gold gained ground in the month but finished the year down, while the Dollar index marginally weakened, but finished up more than 6% in 2021. 

As we kick off 2022, markets have carried the ghosts of 2021 into this year. Inflation, the path of monetary policy and the enduring impact of COVID-19 variants top the bill of risks playing on investors’ minds.

With inflationary pressures mounting, the pace of monetary policy tightening to combat potential ‘runaway inflation’ risks creating bouts of equity market volatility in 2022. On the back of rising prices and tightening labour markets, the US Federal Reserve and the Monetary Policy Committee in the UK have been more hawkish in response to persistent inflationary pressures. In Europe, where we are seeing high but easing inflation rates, policymakers are moving at a more gradual pace amid continued high rates of unemployment. Still, with central banks regionally remaining vigilant, and committing to scaling down the liquidity ‘punchbowl’, developed market inflation is expected to ease in 2022. This would be supported by a further unwinding of lingering supply-chain blockages, allowing demand-supply dynamics to normalise.

Relatively modest inflation in Asia has given central banks slightly more scope to maintain liquidity support for longer, while a further opening of these economies will help to stimulate global supply and demand. However, Emerging Market countries vulnerable to rising US interest rates and a strengthening dollar (with potentially elevated levels of inflation and higher public debt) may need to take more decisive policy action sooner to shore up their economies if the pace of US monetary policy tightening accelerates.

Slowing growth in China remains a risk following regulatory crackdowns to meet policy goals and aid the authorities’ ‘common prosperity’ reform agenda. Arguably though, this has been priced in to earnings growth and equity market expectations for 2022, and relative starting valuations offer good upside potential after a challenging 2021.

However, in the wake of recent COVID-19 outbreaks in Tianjin and Henan province, if the Chinese authorities plan to maintain their ‘zero-tolerance’ policy in the run up the Winter Olympics in February (and potentially beyond this to the Chinese Communist Party National Congress in the Autumn), this could create further market volatility and see nations, reliant on Chinese demand, subsequently lose growth momentum due to the knock-on effects of travel restrictions, extended lockdowns and longer relative isolation and quarantine periods.

With early studies pointing to the ‘Omicron’ variant being milder, if more transmissible, and due to the widespread success of vaccine rollouts, booster jabs and COVID-19 treatments, many nations are looking at easing restrictions and isolation periods in line with infection rate ‘tolerance levels’, and opening travel corridors to keep their economies ticking over and to drive growth as the pandemic endures; but the potential for more severe strains to (re)surface means that we are not quite out of the woods yet.

Geopolitical risks also have the potential to derail the recovery in 2022. Although markets can find it challenging to price these in, and be fairly sanguine in response, any escalation in the Russia-Ukraine tensions or step up in Chinese authorities' efforts to unify mainland China and Taiwan could create a more volatile economic and market backdrop.

Fundamentally, the global recovery is still on track and economic growth remains robust, albeit at a slower pace. On the latest IMF estimates, global growth is projected to be 5.9% and 4.9% in 2021 and 2022 respectively1. At a corporate level, rising capital expenditure should support the ongoing recovery, while decent earnings forecasts and stable margins should provide a buffer in a more uneven and uncertain rate environment.

 

1 https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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