Outlook 2022: Solid foundation for shares
Equities had a great year in 2021, with massive flows, low volatility, and most key indexes posting performance above 20%. After such euphoria and as the new year dawns,
are the lights red or green?
In terms of fundamentals, the economic outlook is solid, with a global growth of 4.4% expected for2022. Corporate profits and earnings forecasts are looking good, especially with demand still so strong and 18-month savings amounting to a substantial reserve for consumers and investors.Inflation is the only cloud darkening this radiant horizon. With production chains scrambled byhealth measures, and consumer appetite sharpened by stimulus plans, there is a major imbalancebetween supply and demand. The resulting bottlenecks and shortages are impacting a greatamount of goods and services. And when supply outstrips demand, prices go up!
Inflation of a structural nature – wage-price spiral looms
At first, the central banks were calling it “transitory”, but inflation has reached structural segments of the economy, and ‘price-wage spiral’ is no longer a dirty word. And so, after delaying, most central banks – with the powerful Fed in the lead – have merged onto the road to monetary policy tightening. With the end of asset purchasing and key interest rate hikes, as well as a reduction in the balance sheet size, the whole toolbox will be thrown at inflation.
It’s only logical: maintaining price stability is the primary role of central banks. Yet for markets now used to accommodating monetary policies, this is a major change. Although the last tightening cycle that ended in 2018 had a bitter aftertaste, does it really equal a drop in the equity markets? Not if you look at history, but on two conditions: the central banks’ schedules need to be clear, to prevent any nasty surprises, and companies must achieve their performance targets. Indeed, faced with higher interest rates, share prices can no longer be assessed by increased valuation multiples, which will have a tendency to decline, but by increased earnings per share.
Reasonable valuations and profits will be decisive in 2022
Finding securities that have both reasonable valuations, protecting them from a drastic contraction of multiples, and fundamentals solid enough to meet earnings expectations, will be one of thechallenges for equity investors in 2022. The other will be leveraging volatility which, after 18 bullishmonths on the market, will show promising entry points. For fixed-income investors, the outlook is dimmer. Amid rising interest rates, not being exposed to duration will be critical, as will diversifying sources of performance. And everyone should keep in mind that the return of inflation is good news – if it leads to monetary policy tightening. Particularly since it is being generated by robust demand. For companies with solid bases and the ability to adjust their prices, the news could be far worse!
From Olivier de Berranger, CIO of LFDE
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