Should we expect a brighter 2022? The outlook for 2022 looks similar to that of 2021 — virus numbers continue to rise and affect everyday life and public services. However, there are some differences and although it might not always feel like it, we are significantly further along the road.
By and large, companies have adjusted and adapted to the pandemic and policies that come with it. The exceptions are industries where pandemic restrictions have had a disproportionate impact, primarily retail, hospitality, and travel & tourism.
It’s important to focus on what you know and recognise the potential risks that exist. Here are some of the factors to consider in 2022 when you’re reviewing your portfolio.
This is one that falls into both camps. We know inflation is high (CPI is 5.1%) and has reached this level far faster than was expected and the Bank of England responded with its first interest rate rise.
Trying to forecast when and how fast interest rates will rise in response to inflation is going to be the focus for markets for much of 2022. Don’t expect many to get the detail right… after all few expected a rate rise from the Bank of England in December 2021.
In the short term, restrictions can lower oil prices and drag on inflation but the longer-term disruption to supply chains, and the need for businesses to recoup losses means that high inflation is a significant risk in 2022.
The disruption we have seen in supply chains and the impact lockdowns have had on people are already affecting wage expectations and these will continue to work into inflation. As such, higher inflation for longer is, in my opinion, a significant potential risk. This will mean valuations will be in greater focus, while value stocks such as banks could well benefit.
Focus on fundamentals
Growth has led the market for many years now and during the pandemic investors went to what they knew and the sectors, such as technology, most likely to benefit or least likely to suffer. However, as the impact of the pandemic recedes, and consumer confidence returns along with inflation we could see a focus on fundamentals and a shift from growth stocks to value stocks.
This doesn’t mean growth is dead or you’ll lose money in growth, but a rebalancing of the performance of different sectors. Valuations between the two are so stretched right now that even a small shift in perspective could result in improved performance. This may mean that stock-market performance at the headline level is more muted though.
The UK market has been cheap for a while and for good reason. Brexit created so much uncertainty that international investors choose to stay away. While Brexit issues continue to hit the headlines, the risks of it are reducing significantly. Companies have adapted and while some sectors are still struggling many issues are slowly being resolved.
The UK market also suffers from a perception of being ‘old economy’ and is full of oil majors and banks. However, it’s important to remember that the price you pay for stocks can matter and with the UK at around a 40% discount to its long-term average there are some attractive bargains to be had.
The UK’s value and income tilt could easily come back into focus in 2022 as interest rates start to rise and dividends recover. Don’t forget that before the Omicron strain surfaced, forecasts for UK growth in 2022 were higher than the US, Europe and the world as a whole. M&A activity has already picked up, along with shareholder activism. It may not be investors buying the UK market, but someone is.
A rotation into value from growth and a focus on recovery is a challenge for the US market where growth stocks have dominated. Many of these companies are still world-leading, but valuations are high and the stimulus programme approved in November should benefit other areas of the markets.
US exposure is likely to need reviewing and it might be an opportunity to take some profits in the higher-growth areas. However, even with high valuations, I wouldn’t give up on the US market. The US consumer is alive and well, they have adjusted to the withdrawal of stimulus checks and the savings rates remain strong suggesting that the $2.4trn in consumer savings is still to be tapped.
The US system is well designed to bounce back from crisis and has a strong focus on economic growth, but refocusing on areas with less lofty valuations makes sense. US small and mid caps look more attractive and would benefit from a greater focus on domestic growth as global supply chains are tested.
The recovery in 2021 has been strong and reflected in healthy company profits. However, Europe has seen some tightening of COVID restrictions in recent months which could delay the recovery from the pandemic, although not derail the process.
The momentum in company earnings and consumer demand should continue in the first half of 2022 and although performance has been good, valuations remain at a discount to the US market. Inflation remains a risk for the region but interest rates are not likely to rise until later in 2022.
Europe is becoming a leader in sustainable and environmental sectors such as green energy. This could provide an opportunity for companies with a sustainable focus as interest from investors continues to grow.
The country has benefited from a lower Covid infection rate, and as a result, has largely been able to reopen its domestic economy with limited restrictions. In addition, incoming President Fumio Kishida announced a US$383bn stimulus package to support lower income households, students and small businesses.
Japan has lagged other developed markets in lifting restrictions, which means there is also a delay in the recovery of company earnings. This should feed through in the period up to March 2022. As in the US, smaller and mid-sized companies should benefit from the domestic recovery.
The outlook for China looks more muted. There has been a clear policy change from Chinese leaders. Previously a slowdown in the property market would have resulted in huge macroeconomic stimulus, but the response has been muted — it looks as though China wants lower growth rates in the sector, but avoid a collapse. This new approach has also affected Chinese tech giants. Although it will create long-term opportunities, the risks are high in the short term.
If there are lessons to be learnt from the pandemic and how it affects businesses, is that trying to predict what will happen in the short term is notoriously difficult. In addition, well-managed companies have demonstrated they can be very resilient in the face of major disruption. Building a portfolio is about having exposure to good quality businesses and a diverse range of investments that mean you can benefit from a range of possible scenarios and have some protection in the difficult times.
Photo by Jaël Vallée on Unsplash