2021 was a booming year for equity investors, but it is evident that 2022’s backdrop is likely to be quite different. We believe stock market investors will keep a keen eye on monetary policy, as this is expected to drive volatility and stock market valuations.
After a rapid recovery following the pandemic, global stocks have moved into the mid-cycle stage of the equity market cycle. Economic supporting factors have become weaker. Notably, monetary and fiscal stimulus – and, hence, less liquidity – has been fading.
Monetary policy, volatility and inflation
Volatility – which increased at the start of 2022 – is likely to remain more elevated, as US Federal Reserve (Fed) policy uncertainty often drives equity market volatility. The potential impact of geopolitical events on volatility should not be ignored either.
The second key aspects are valuation and monetary policy. If sovereign bond yields remain at historically low levels, global equities can sustain higher multiples to earnings compared to historic averages. Essentially, this is opportunity cost: low bond yields make equities appear relatively more attractive.
There is still only a modest probability of bond yields moving materially higher, given inflation will likely peak in Q2 2022. Added to this, demographics, technology advancements and high debt levels are all deflationary factors over the longer term.
Tighter monetary policy will also be crucial, particularly from the Fed, in taming inflation and tempering a rapidly growing economy. The inflation discussion is likely to rumble on for some time. A goldilocks (not too hot, not too cold) environment – with inflation between 1-5% – is rarely a negative outcome for equities. Sustained inflation above 5% is likely to be a smaller risk for now.
Perhaps the most compelling reason not to be negative on equities through 2022, is the earnings outlook. Global stock market earnings are forecast to show high single-digit growth next year. The risk is still more weighted towards a higher number, as the global consumer – and growth momentum – remain strong.
Ultimately, this suggests that equities will be able to generate mid-single digit returns thanks to earnings advancements. However, this may well be accompanied by higher volatility.
Quality dominates
It is likely that high-quality equities will dominate in 2022. These are stocks that are not dependent on economic supporting factors for growth. Defensive compounders and structural growers will be better placed to deal with a more challenging environment due to monetary and fiscal tightening. Conversely, cyclical equities may struggle, as economic activity tempers from a very high level and cost pressures remain.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q1 2022 here.
Issued: January 2022
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