It would be a challenging task to maneuver the equities markets in 2022. Markets will have to contend with i) potential disruption from the Omicron variant, ii) China’s reforms, iii) tighter liquidity, iv) higher inflation and v) the impact from stricter environmental standards. This is at a time when global growth slows on valuations much higher than historical averages. We do see bumpy roads ahead with selective investment opportunities rather than broad-based rallies.
Figure 1: MSCI Indices Percentage Returns in USD (%)
Source: Bloomberg 3 January 2022
Note: ACWI – All Country World Index, IT – Information Technology
Global equities returns over the past three years were pretty remarkable considering that there was a global pandemic from 2020 which is still not totally under control. An explanation could be that the massive liquidity injected into the financial system by quantitative easing, lower interest rates and government subsidies have led to strong performances in risk assets. One may also question if risks assets would continue to do well given that the liquidity cycle is turning. Another question could be whether growth sectors like technology would continue to outperform cyclical sectors this year. We highlight five uncertainties in 2022 which could lead to a bumpy ride ahead.
FIVE KEY THEMES IN 2022
1. The first thing to look out for would be the impact of the Omicron variant and whether this is the last major disruption from Covid-19 as we transition into a post-Covid-19 world. The emergence of the Delta variant led to a slowdown in global growth in the third quarter last year and global equities sold off accordingly. However, the global equities market recovered at the end of last year despite the emergence of the Omicron variant. The consensus view was that the Omicron variant, despite being more transmissible, was less severe than the Delta variant. Our view is that global equities could be priced for perfection and further disruption by the Omicron variant could still lead to short term corrections. That said, our base case scenario is that any potential short term volatility from the Omicron variant would likely subside as the pandemic could finally end with sufficient vaccination globally
2. A major surprise last year was the extent of the sell-off in the Chinese equities markets brought about by new regulations and the extent of dislocations in the property sector. Market participants were worried that the “common prosperity” policy could lead to lower profitability for private companies. In a separate piece, we explained that China was in the process of reforming their economy to achieve more equitable and sustainable growth. We expect China to loosen at the margin if their economy slows further with cuts in the Reserve Requirement Ratio, cuts in lending rates and an increase in quotas for bank loans. The Chinese equities market may find firmer footing in 2022 on better investor sentiments as China loosens as compared to tightening at other major markets. Stronger economic growth would also be positive to its trading partners in Asia and thus be positive for Asian equities.
Figure 2: MSCI World Index
Source: Bloomberg, 28 December 2021
3. We are now at the tightening phase of the cycle in most markets and investors would question if the withdrawal of liquidity would be a challenge for risk assets. We expect tapering in the US to end before June 2022 and interest rates hikes as early as the third quarter of 2022. The withdrawal of liquidity would likely weigh on risk assets. However, we do not expect the Federal Reserve to over-tighten as they are inclined to be dovish as they prioritize achieving maximum employment over price stability. Monetary policies globally are like the US in that they are unlikely to tighten excessively and cause major disruptions to equities markets. That said, the withdrawal of excess liquidity is inherently negative for risk assets.
4. We think that investors were too complacent on the inflationary front. For example, US inflation was as high as 6.8% in November 2021 but 10-year treasury yield was only at 1.5% as at 28 December 2021. Although we agree that inflation would ease in 2022 as energy prices eases and disruptions to global supply chains eventually get resolved, we are of the view that longer term inflation could be higher than pre-pandemic levels due to longer term factors like deglobalisation, a China exporting less deflation and Big Technology Firms becoming more monopolistic. This suggests challenging conditions for bond returns.
5. There is increasing push towards stricter environmental regulations as demonstrated by the pledges during the 2021 United Nations Climate Change Conference (COP26). There is also a growing appetite by both the retail and institutional investors to focus on sustainable investments. The enormous capital expenditure required by dirty industries like steel, coal power generation and transportation would face headwind. On the other hand, we see business opportunities for companies with expertise in green energy technology, hydrogen, batteries and electric vehicles and also these stocks of such companies would attract higher valuations due to investor interests.
Figure 3: US 10-year Treasury Yields
Source: Bloomberg, 28 December 2021
THREE KEY CONCLUSIONS
1. Current valuations are on the high side (Figure 4), with most major markets trading at a premium to historical averages. Earnings growth rates in most markets are also expected to slow in 2022 as compared to 2021. The stellar performance for global equities, especially US equities, is unlikely to be repeated in 2022 due to high valuations especially when liquidity is about to be taken away. We do see short term trading opportunities at more cyclical equities markets which are trading at a relative discount and which would benefit from the transition towards a post-Covid-19 world. Markets like the Singapore equities market which would likely benefit from further normalization in global travels and higher interest rates benefitting the banking sector. Investors who are looking to be exposed to the Singapore equities market could consider the LionGlobal Singapore Balanced Fund.
Figure 4: Consensus earnings forecast strong for this year and next
Source: Thomson Reuters, 17 December 2021
Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
2. As explained above, we are also positive on Chinese equities as China is on an easing cycle. Asia benefits from a growing China and investors could invest in a growing China through our LionGlobal Asia Pacific Fund which aims to achieve long-term capital appreciation by investing primarily in the Asia Pacific (excluding Japan) equities market. Investors who want a more focused investment strategy may consider our LionGlobal China Growth Fund. Those who are looking for a passive strategy to participate in the longer term recovery in the Chinese market can also consider the Lion-OCBC Securities China Leaders ETF or the Lion-OCBC Securities Hang Seng TECH ETF, which are listed on the Singapore Exchange (SGX).
3. From a longer investment horizon, we continue to be positive on companies that participate in long term disruptive innovative trends. It is clear to investors that technological innovations are equally important post-Covid-19 although valuations of many of such companies are likely to be richer than those in cyclical industries. It could be possible that investors may favour cyclical sectors in the shorter term but we expect investor interests to return to growth sectors once the relative valuation gap closes. Investors looking for longer term investment opportunities may consider our LionGlobal Disruptive Innovation Fund, which is invested in 15 disruptive innovative themes.
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