Paul O’Connor, Head of Janus Henderson’s UK-based Multi-Asset team, outlines why he believes that, while conditions look good for another year of solid growth, investors should expect surprises and occasional market setbacks.
- Given the impressive progress on vaccines, we expect COVID flare-ups to provide occasional disruptions to the global economic expansion, rather than overwhelming the solid recovery trend.
- One risk overshadowing financial markets is the possibility that short-term and long-term real interest rates are much lower than they should be, risking an abrupt future repricing.
- The risk-return outlook still seems most favourable in developed market equities. We are less optimistic for emerging market equities and fixed income, strategically preferring listed alternatives given their scope for diversification.
What themes do you expect to most influence multi-asset investing in 2022?
Although many uncertainties overshadow the outlook for 2022, it does look set to be another year of solid global growth, driven by the ongoing reopening boom in the major developed economies. Much greater uncertainty surrounds the outlook for inflation and its impact on monetary policy.
The near-term focus is on the speed at which bottlenecks in global supply chains clear, alleviating shortages and pricing pressures in goods and commodity markets. These tensions should ease in the first half of the year, assuming no significant new economic restrictions are imposed in key producing countries. While goods prices have been the main drivers of inflation during the pandemic so far, service sector inflation could be the big story for 2022, as leisure, travel and other labour-intensive service sectors see a surge in pent-up demand in many major economies.
Central banks often look through rises in goods inflation, but they usually respond more promptly to inflationary pressures in labour markets and service sectors, as these are more likely to be self-sustaining and persistent. Investor risk appetite is likely to be highly sensitive to developments on this front in 2022, given the potential implications for the speed at which central banks normalise monetary policy.
Of course, developments on the health front still have scope to disturb global growth, inflation, and policy dynamics. With less than half of the world’s population fully vaccinated against COVID-19, it seems inevitable that there will be further setbacks in the war against the pandemic in 2022, as more new variants break through. We expect such flare-ups to provide occasional disruptions to the global economic expansion, rather than overwhelming the solid recovery trend. However, the global health situation remains highly fluid and we remain alert to the possibility of more troublesome outcomes.
Where do you expect the most compelling opportunities?
From a multi-asset perspective, the risk-return outlook still seems most favourable in developed market equities. Peering through the current fog of coronavirus uncertainty, we see growth, policy, and investor positioning looking relatively attractive for UK, Eurozone and Japanese stocks. Although, emerging market equities were big underperformers in 2021, we are not yet convinced that China-related risks are priced in sufficiently to justify building strategic overweights here.
Once again, we enter the year with limited enthusiasm for government bonds and credit, given low yields, tight spreads and fading central bank support. We strategically prefer listed alternatives. These offer plenty of scope for diversification, income streams and exposure to many potential secular growth themes, such as renewables, infrastructure, and logistics.
What is the single most market-underappreciated risk?
One big risk overshadowing financial markets in 2022 is the possibility that short-term and long-term real interest rates are much lower than they should be, risking an abrupt future repricing. We see this as a tail-risk scenario, rather than being our central case.
Unusually low real interest rates played an important role in dampening the economic impact of the pandemic. However, it is questionable whether monetary policy should still be on such emergency settings, with growth booming and inflation at multi-decade highs in many major economies.
Furthermore, the pandemic has transformed attitudes to economic policy in the developed world, leading to a shift towards a more active use of fiscal policy to counter the forces of secular stagnation that have kept interest rates and bond yields trending lower since the 1990s. The impact has been striking. While most recessions have a lasting impact on growth through the damage they inflict on consumer and corporate balance sheets, consumers are emerging from this one with sizeable cash savings balances, thanks in part to generous government initiatives.
If pandemic-related restrictions on economic activity recede next year and consumers start putting their excess savings to work, the risk is that financial markets will need to reprice the path for interest rates and real bond yields sharply higher in some developed economies, with secondary consequences for equities and other risk assets.
Is there a particular chart that best sums up where we find ourselves at the turn of the year?
It is a remarkable fact that US equities have delivered returns of more than 340% over the past decade while non-US markets have delivered just over 90% (30 November 2011 to 30 November 2021). While the structural outperformance of US media, technology and communications behemoths has been a big part of the story, there is also a cyclical element to this relative performance trend as well. US equities tend to outperform when growth stocks are outperforming value stocks globally and when bond yields are falling. These themes have been broadly supportive of US equity outperformance for more than a decade and were particularly strong during the first year of the pandemic in 2020. However, both trends have begun to look more fatigued over the past year and look vulnerable to some reversion in 2022, casting reasonable questions about the durability of the decade-plus outperformance of US stocks.
Exhibit 1: Growth stocks and US equities have been the winners for the past decade
Source: Janus Henderson Investors, Bloomberg, 31 December 2000 to 2 December 2021. Showing relative performance between the MSCI All Country (AC) Growth Index and the MSCI AC Value Index, and between the S&P 500 Index and the MSCI AC ex-US Index, in US dollars, rebased to 100 at start date. Past performance is not a guide to future performance.
What do you believe is the most important takeaway for multi-asset investors in 2022?
It is hard to avoid the conclusion that the outlook for financial markets in 2022 is unusually opaque, obscured by uncertainties surrounding fast-moving developments on the economic, health and policy fronts. The pandemic has ushered in dramatic changes to monetary policy, fiscal policy and consumer behaviour and has generated some unusual imbalances and frictions in the global economy. Starting from such an unfamiliar economic landscape and with many price and relative return trends looking extended in financial markets, market predictions are likely to be even less reliable than usual.
Investors should expect surprises and occasional market setbacks in 2022. With many asset markets looking fully valued and central bank support receding, the recent uplift in market volatility is probably a good taste of what lies ahead. In this environment, diversification should be valued and a dynamic approach to asset allocation could likely be rewarded.
Inflation: The rate at which the prices of goods and services are rising in an economy. The consumer price index (CPI) and retail price index (RPI) are two common measures.
Monetary policy/fiscal policy: Monetary policy is that which relates to policies of a central bank, aimed at influencing the level of inflation and growth in an economy. It includes controlling interest rates and the supply of money. Fiscal policy relates to governments, and the setting of tax rates and spending levels.
Risk assets: Financial securities that can have significant price movements (hence carry a greater degree of risk). Examples include equities, commodities, property and bonds.
Overweight: To hold a higher weighting of an individual security, asset class, sector, or geographical region than a portfolio’s benchmark.
Bond yields: The level of income on a security, typically expressed as a percentage rate. Higher bond yields mean lower bond prices and vice versa.
Bond spreads: The difference in the yield of a corporate bond over that of an equivalent government bond.
Market volatility: The rate and extent at which the price of a portfolio, security or index (market), moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.
Growth and value investing: Growth investors search for companies they believe have strong growth potential to grow their earnings at an above-average rate compared to the rest of the market (leading to a higher share price). Value investors search for companies that they believe are incorrectly undervalued by the market, with the hope that their share prices could perform better over time.
Emerging markets: Countries that are transitioning away from being a low income, less developed economy to one that is more integrated with the global economy and is making progress in areas such as depth and access to bond and equity markets and development of modern financial and regulatory institutions.
Cyclicals: Companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as miners. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclical companies.