2021 was a good year for investors with equity markets delivering strong returns. The removal of coronavirus restrictions, made possible by the global rollout of vaccines, generated one of the sharpest economic recoveries in recent times.
One by-product of this renewed activity was higher inflation as shortages in goods and labour, due to disrupted supply chains, struggled to keep pace with the sudden increase in demand. Despite higher inflation and the emergence of the Delta and Omicron strains of coronavirus, throughout 2021 corporate profits jumped 50% compared to 2020; almost double the growth analysts predicted at the start of the year.
As we enter 2022, the outlook for growth and the global economy remains positive albeit lower than witnessed in 2021. However, as always, there are potential risks and headwinds to this outlook. Below, we outline what we think these might be and their possible impact on markets and the global economy.
Vaccines and Variants
The Delta and Omicron variants are unlikely to be the last significant coronavirus variants to emerge. Encouragingly, studies have shown that the current Pfizer/BioNTech and Moderna vaccines still provide adequate protection against serious illness. However, predicting the future – including the potential for variants – is an impossible task. More recently, government advisers are beginning to explore policies that deal with the virus as endemic rather than a pandemic. If this is the case, we would anticipate a lower risk of future restrictions impacting the global economy and consumer activity this year.
Inflation is likely to remain above most central banks’ target rate of 2% throughout 2022 but we would expect it to come down from the current levels (a global inflation rate of circa 4.5%) as we move through 2022. This is based on an expectation of supply chains recovering and catching up with demand, the base effects from 2020 rolling off and being replaced by 2021’s higher prices, along with some loosening of the labour market which should limit further wage rises. So far, businesses have been able to pass on higher input prices to customers and therefore maintain their profit margins. Whether they will be able to continue this throughout 2022 will likely be a key determinant of inflation as well as corporate profitability and subsequent equity returns.
Central Bank Policy
Markets have priced in interest-rate rises across the globe as central banks attempt to avoid inflation getting out of control. The Bank of England has been the first of the major central banks to act and the Federal Reserve is expected to hike rates in February with a further two rate rises later in the year. Conversely, the European Central Bank still believes its interest-rate policy remains suitable and plans to hold rates low for the remainder of the year. In the emerging markets, Brazil, Mexico, South Africa and South Korea’s central banks have all raised rates. Other emerging countries are likely to follow suit in 2022 as they try to combat inflation and maintain the value of their currencies relative to the US dollar.
In addition to rate rises, we are also seeing the scaling-back of central banks’ asset-purchase programmes. Though this was anticipated, the rate at which it is enacted could end up being faster than markets are currently pricing in.
All in all, with the impact of coronavirus hopefully receding, we expect central bank policy to play a more pivotal role in financial markets. As monetary policy overall becomes tighter, we would not be surprised to see higher levels of volatility during 2022. Having said that, central banks are all too aware of the impact their decisions have. Maintaining market stability is a key part of their mandate and so to ensure this is the case, we can expect them to continue to communicate clearly with any major change signposted well ahead of time to avoid spooking markets.
In 2020, governments put aside their fears of debt, budget deficits, and borrowing costs as they took significant steps to reduce the impact of coronavirus restrictions on their economies. Further spending at the level seen in 2020 is unlikely. However, post-pandemic they do seem more at ease with maintaining higher deficits going forwards. The EU, Japan and UK have outlined large spending packages for this year which are focused on future growth and meeting targets set out by COP26.
Much of the fiscal spending over the last few years has been targeted at filling the gap created by coronavirus restrictions. Spending plans are now in place to fund new infrastructure developments, social programmes, and the sustainability transition. Though we expect fiscal spending to be lower over 2022, it is taking place with a more favourable economic backdrop. Therefore we would expect its impact to remain positive to markets as aggregate demand increases within the economy.
Growth in China
China, now the second-biggest economy in the world, experienced strong levels of growth throughout 2020 and 2021. They were the first country to face coronavirus and were successful in bringing it under control quickly through aggressive restrictions and tracking. However, China’s property sector has shown significant weakness as one of the country’s biggest property developers, Evergrande, defaulted on its bond payments starting a domino effect within the sector. As the real estate sector makes up about 20% of China’s economy, the country’s central bank, Peoples Bank of China (PBoC), has stepped in to ease the pressure felt in financial markets. The situation is still unfolding; however, it is likely the PBoC will be forced to add more support over this year to avoid further defaults and reduce the drag on overall economic growth in the country.
Another impact on growth is the Chinese government’s continued pursuit of a “Zero Covid” strategy. This is implemented through tough restrictions, even in cities where very few cases of coronavirus are discovered. Clearly, these restrictions will have an impact on activity and economic growth going forwards.
Overall, global economic growth in 2022 is likely to remain above the historical average, although not as strong as last year as inflation, tighter monetary policy, and more conservative government spending packages will weigh on economic activity.
Coronavirus is still with us and is likely to be so for some time. Though the future impact of the virus is not clear, most governments’ appetite for full lockdown measures is waning which should ensure economic activity is not artificially impacted by restrictions to the extent it has been.
Despite a tumultuous couple of years, global equities have generated double-digit returns and so we must be mindful of this when considering expected returns going forwards. As long as the economic environment continues to justify current equity valuations, there is no reason markets cannot produce another year of positive returns.
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.