Investment and economic outlook for 2022
- Shunil Roy-Chaudhuri
- 14 January 2022
- 10 mins reading time
On 14 December, we hosted a webinar in which we reviewed 2021 and discussed the investment and economic outlook for 2022. This briefing is based on that content.
You can view the slides from the webinar here.
Another year dominated by COVID-19
In the UK, before the arrival of the Omicron variant, we saw cases of COVID dropping due to the vaccine rollout while people were also returning to their offices. But COVID continued to put the NHS under great pressure.
Governments across the world injected money to sustain their economies during the pandemic. In the UK, Chancellor of the Exchequer Rishi Sunak supported Britain’s economy via the furlough scheme. But there are concerns that the accompanying UK government debt burden could be overly large and future generations will have to pay it back.
The hugely important COP26 climate conference took place in Glasgow. Prime Minister Boris Johnson said the world is at ‘one minute to midnight’ on climate change. New US president Joe Biden pushed through a programme of investments in green technology and in infrastructure, believing his country needs a shot in the arm to get it through the pandemic.
Supporters of ousted US president Donald Trump invaded the Capitol in Washington, D.C., on 6 January, following his electoral defeat. Some of the perpetrators are now going to jail and the incident shows how fractious US politics had become.
The Delta variant of COVID-19 was first identified in India in late 2020 and was declared the dominant strain worldwide in June. It triggered a spike in cases, especially in the UK and US.
Mercifully, the number of daily COVID fatalities in the UK was far smaller than the number of people contracting the virus. This demonstrates that the vaccine is working and the country is coping with the disease far better than in May 2020. We may be seeing a ‘new normal’ in how people work and shop and there has been a lack of panic in the UK, US and Germany.
Looking at the performance of the MSCI North America Index (see Chart 1), there is no clear point at which the Delta variant had an impact on the markets. This suggests the markets factored in a solution to the pandemic.
There is uncertainty about how big the impact of the Omicron variant of COVID-19 will be. This uncertainty, however, is influencing the financial markets and our own thinking.
Thankfully the impact in South Africa, where the strain was first identified in late November, has not been as great as it was with Delta as the Delta symptoms were more serious. In the UK, double vaccinations plus the booster vaccination will reduce the negative health impact of the new variant, but a spate of infections could strain the NHS.
The UK will probably avoid a lockdown (although this is a very close call), particularly given the impact this would have on the economy. Even if the negative health impact of Omicron is not as serious as that of Delta, restrictions have been introduced in Britain that will have a negative economic impact on the leisure and hospitality sectors.
We are more likely to see lockdowns in Europe, as European nations have had less effective vaccine rollouts and been battling harder with the Delta variant. In the US, any restrictions will be imposed on a state-by-state basis, but we believe they need to ramp up their booster programme.
The UK government provided widespread financial support to businesses during previous lockdowns, but that support has now ended, leaving businesses to fend for themselves. In our view, we don’t need another blanket furlough scheme, but we do require targeted economic support, focusing on vulnerable sectors such as hotels and restaurants.
We need a week or so to see the impact of Omicron. However, the Bank of England did raise interest rates to 0.25% in December, despite uncertainties over the variant.
The big economic uncertainty is inflation, which stands at its highest levels for 30 to 40 years in many economies.
The global economy is unbalanced, as COVID restrictions have driven up demand for consumer products, but reduced demand for services such as hotels. This has contributed to bottlenecks at ports and long delivery times for goods.
Prices have gone up as demand for products outstrips supply, driving inflation figures higher. However, the Baltic Dry Index, which measures the cost of shipping raw materials such as steel, has come down from an October high. This suggests supply chains might be easing and prices might be beginning to peak. Even so, people are still waiting a long time for a new car and probably paying more for it.
The oil price has also risen as the world emerged from COVID restrictions. It has fallen somewhat following the release of strategic reserves by the US and China and the Saudis’ increased oil production, but prices remain elevated.
Inflation in the UK, as measured by the Consumer Price Index (CPI), was 5.1% in November (see Chart 2), significantly above the 2% target the government sets the Bank of England (BoE). However, we have had long periods of being under target, suggesting the BoE may have some flexibility here.
Even so, a robust case can be made for the BoE to raise interest rates. Unfortunately, the oil price and goods shortages are not under BoE control and we expect inflation to peak at 5.5% in April 2022. We do, though, expect inflation to come under control in the second half of 2022.
Wages have accelerated in the US and we think it likely they will rise further. Fewer people than expected are coming back into full-time work, as COVID restrictions encouraged many to take early retirement or switch to part-time employment. In fact around three million people have dropped out of the US labour force, leading to shortages and more wage rises, which drive inflation upwards.
Shortages due to COVID could continue for some time, making goods more expensive and limiting the purchasing power of consumers, despite any increases in their wages. However, such a squeeze on purchasing power could go on to act as a brake on price rises, suggesting we might not be far from peak inflation. Indeed we expect US inflation to hit a high in early 2022, as the annual change in the oil price peaks.
Biden has secured the backing of US Congress for billions of dollars of additional spending, much of which will go on infrastructure such as roads, hospitals and green initiatives. However, it’s starting to look as if there’s been too much stimulus, with US retail sales now 20% higher than before COVID. However, this is partly driven by pent-up demand: people’s savings rose in the US during lockdown, leaving them with more to spend today.
Biden could, though, be storing up problems for the future, as taxes are not currently being raised to fund his spending programme. This suggests they will have to be increased at a later date.
In the UK, the government is ending its emergency fiscal stimulus and taxes are rising. In contrast, the Eurozone is expected to maintain its fiscal stimulus programme.
We estimate there’s still around $2.2 trillion (£1.7 trillion) of excess savings in the US, due to a fall in consumer expenditure during lockdown. Around a quarter to a third of these savings will probably be spent and we expect this to drive up consumption and keep economic growth going in 2022.
Purchasing Managers’ Indices (PMIs) spiked down sharply in March 2020, due to the impact of COVID. However, the JP Morgan Global Composite PMI then bounced back firmly and sharply. In 2021, the composite index rose between January and May, only to fall back (while still signalling economic expansion) and then rise again from August. PMIs are based on monthly surveys of supply chain purchasing managers across various industries and they can indicate economic prospects in the manufacturing and service sectors.
Chinese economic growth has been a little slower, as it has prioritised eliminating any COVID outbreaks. But global growth has generally been strong, with central bank and governmental economic policies driving the recovery. However, these supportive policies are coming to an end now.
We expect Chinese growth to decelerate and Europe to become more of a driver of global growth in 2022. We also expect interest rates in the UK and US to rise, but at a slow pace.
There is a lot of political uncertainty in the UK. Nonetheless, given its high vaccination and booster rates, Britain could be one of the better placed economies to emerge from Omicron. This could make the UK attractive and boost sterling in 2022. Brexit is a headwind, though, and has negatively impacted exports to Europe. But this could just be due to teething problems while new agreements become established.
Global equities, as measured by the MSCI World index, have made remarkable returns of more than 20% since the start of 2021. But this was against a backdrop in which markets fell by more than 20% in early 2020.
Commodities also rose strongly, with the Bloomberg Commodity Index up by 30% in the year to the end of November, helped by oil price rises. But investment grade bond and government bond prices fell a little, partly due to investors shunning bonds in favour of shares.
UK equities have not performed as strongly as global equities. Over five years, UK equities have risen by around 30% while the MSCI World index is up by 93%.
To understand this, we need to compare the UK market to the rest of the world. The FTSE 100 contains lots of banks, pharmaceutical companies, utility companies and mining and oil groups. In contrast, the US S&P 500 index contains Amazon, Facebook, Netflix and other technology giants. These tech growth companies have driven global stock markets upwards. Even so, UK universities create great technology start-ups and many global technology companies have bought into these.
Regarding the UK’s large oil companies, we note that BP and Shell contain attractive renewable businesses within them. We want to support these companies as they transition out of oil into sustainable resources and we accept this transition won’t happen overnight.
The strong global equity performance since the start of 2021 suggests markets may have gone a bit too far and we may be unlikely to get double digit returns in 2022. But we think there is scope for global shares to continue to rise.
In particular, there are favourable tailwinds for equities, with the implementation of the Biden stimulus programme and the global economy opening up from COVID restrictions. Meanwhile, central bank bond-buying programmes are coming to an end, which could reduce bond prices.
We think UK equities are priced too low. This pricing partly reflects uncertainty about the implications of Brexit, leading investors to put their money elsewhere. But we expect UK interest rates to rise, which could benefit British banks. We also think there is scope for the oil price to rise further, which could help UK oil groups and support the FTSE 100 index.
The global technology sector has performed very strongly and, as long as earnings come through, that’s appropriate. However, some parts of the market could be susceptible in 2022, although we are not suggesting a crash or that markets are expensive. But the recovery in asset values has been strong this year, so we are more cautious about 2022: we think asset returns should be good, but not as good as 2021.
Past performance is not a reliable indicator of future results. The value of investments and the income from them can fall as well as rise and are not guaranteed.
Any views expressed are our in-house views as at the time of publishing.
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