After the global equity market boom of the past 21 months, the outlook for 2022 is far more challenging, which has important investment implications.
Material tightening from the US Federal Reserve and rising bond yields support a more cautious asset allocation – we are very underweight bonds and US equities, and slightly underweight growth assets, despite zero cash rates.
The outlook favours value ahead of growth, cyclicals over bond-sensitives and ex-US over US.
Significant China policy easing should be positive for emerging markets after substantial underperformance.
For the year ahead, we see five major global investment themes:
- The Omicron wave to be short and sharp, with little impact on markets. The Omicron variant of COVID-19 is driving a sharp spike in new cases globally but has yet to result in a large increase in deaths or restrictions on economic activity.
- The robust US boom to lift world growth, earnings and inflation. The US economy is in an inflationary boom, growing rapidly as it pushes through full employment. This expansion should prove difficult to stop.
- US Fed to tighten policy materially more than expected. With the Fed’s target inflation measure moderately above two per cent for some time now and maximum employment satisfied, the case for accommodative policy disappears. As such, we expect the Fed to lift interest rates, starting in March 2022, and at a much faster rate and with a higher terminal rate than markets currently discount, unless Omicron drives a dip in the economy.
- Bonds and growth stocks to be tested. US Fed tightening should particularly test the US bond market, but higher bond yields should also pressure equity market valuations, particularly in the US.
- China to significantly ease as the US tightens. China looks very different to the other major economies and should significantly ease policy ahead of October’s China Communist Party Congress. Structurally, we see a number of headwinds to China’s growth: negative demographics, stemming from the long-running one-child policy; elevated non-financial debt levels at 222 per cent, double pre-GFC levels, and above most advanced economies; trade and foreign direct investment headwinds, reflecting trade tensions, particularly with the US; and food security issues, with surges in food inflation every five years or so.
Chris Harris is a representative (no 435773) of Ord Minnett Ltd, AFS licence 237121. This article contains general financial advice only.
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