2022 outlook: Markets have reached ‘a major inflection point’ — is more volatility on the way?
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2022 will bring with it a trio of challenges, asset manager T.Rowe Price says; tighter liquidity, slowing growth, and higher inflation.
So get ready for a rockier ride where defensive sectors such as healthcare will prove their worth, as investors pivot out of cyclical industries tied to the reopening trade.
In that environment, Randal Jenneke, TRP’s Head of Australian equities, is becoming “increasingly cautious” — particularly as global equity markets retest all-time highs heading into the end of the year.
Slowing growth is likely to be a bigger drag than rising inflation next year, Jenneke says. And watch out for more wobbles, as policy makers are trying to delicately turn back the liquidity taps, following their historic post-COVID cash splash.
“The withdrawal by governments and central banks of massive post-pandemic stimulus is set to become a significant headwind for global growth in 2022,” Jenneke said.
Since March 2020, it’s been a healthy tailwind.
Massive fiscal deficits, 0% interest rates, and plenty of central bank liquidity through bond purchases. Will markets adjust?
When it comes to post-COVID policy, we’re at “a major inflection point, as QE (quantitative easing) support is ending,” Jenneke says.
Smaller Emerging Market (EM) economies are leading the way, with rates already rising in some countries.
Among the world’s major developed economies, growth has snapped back from the post-COVID shock — a clear indication that the historic policy support measures are less warranted.
“However, markets may still protest loudly when support is withdrawn next year,” Jenneke says.
At this point, just about every equity investor is aware inflation is running at 30-year highs.
So far, global stocks have done a good job of digesting the prospect of US rate hikes in next year.
But a recent surprise from Fed Chair Jerome Powell — who said bond purchases may have to be pulled back faster than expected — was enough to give US stocks the jitters earlier this month.
Growth has returned, but so has inflation. To the extent policy makers are choosing to tame inflation – that may also drag on growth.
“Contradictory fears of policy withdrawal and higher inflation suggests a difficult quarter or two lies ahead,” Jenneke said.
In turn, investors “will need to navigate their way carefully through potentially volatile, fragile markets”.
Powell and the Fed are on deck this week (Wednesday night), when the US central bank meets for its next policy meeting.
In his recent comments, Powell said inflation is proving stubborn enough that the Fed should probably drop the word ‘transitory’ from its lexicon.
But for its part, T.Rowe Price is in agreement with the Fed that global inflation pressures will start to ease back in 2022.
Instead, Jenneke attributed some of the upward pressure on inflation to short-term factors unique to the pandemic, such as supply chain shortages.
He also noted a feature of annualised 2021 inflation data; low base effects, after inflation slumped in 2020. Rule that out for next year.
“Rather the reverse will apply, as the higher base in 2021 should see annual inflation decelerate as 2022 unfolds,” Jenneke said.
In fact, it’s this simple: “The conditions for a surge in global inflation next year are absent.”
On the home front, Australia too “does not have an inflation problem”, Jenneke said.
The RBA is waiting for wage growth in its inflation equation, and various COVID-19 lockdowns have taken their toll.
As a result, the domestic economy is still operating with “a large margin of spare capacity” — not the setup for wage increases to drive sustained inflation growth.
So while the market disagrees with the RBA’s 2024 timeline for rate hikes, Jenneke said Australia’s central bank “is right not to worry unduly about domestic inflation pressures”.
Instead of the big bad inflation genie, Jenneke said investors should be on the lookout for companies that are struggling to maintain their post-COVID earnings trajectories.
“Recent surveys point to a growing uncertainty over corporate earnings forecasts in FY22,” he said.
In aggregate, T.Rowe Price thinks markets are approaching the “deceleration phase” of the post-COVID business cycle, defined by a tapping of the brakes on economic growth and company profits.
“Economic indicators have recently started to disappoint, and GDP growth trajectories are being revised downwards in most parts of the world,” Jenneke said.
In turn “we believe the impact of slowing growth will be the factor that will matter more to investors in 2022, as inflation concerns start to fade”.
So are high-growth tech stocks — the market darlings of the post-COVID era — set to get their wings clipped amid tightening liquidity, higher rates expectations and rising bond yields? Not so likely, Jenneke says.
Rather, what he’s pointing to is something more like stagflation, where growth slows at the same time as inflation rises, and monetary policy starts to tighten.
“Total market returns can be expected to be lower than in the recent past,” he said.
“Overall, we see the market environment in 2022 as being suited to quality defensive companies.”