Insights

Our thoughts on the outlook for 2022

Thursday, 09 December 2021

The past two years have seen a fight for dominance between the tiniest thing in the world (now aptly named 0 micron) and the largest global economic stimulus on record. The virus, and measures to control it, laid economies low and could have ushered in a prolonged depression, so deep was the resulting recession. Instead, governments devoted record sums to accelerating the development of vaccines and treatments, while providing liquidity and other financial support to individuals and businesses, to prevent bankruptcies and failures, effectively cryogenically preserving the economy until society found a cure or learnt to cope.

Their efforts were successful, although the speed of the economic rebound (amid the continued pandemic disruption of trade flows) ran ahead of the world’s capacity to produce, leading to shortages and rising prices. As 2021 draws to a close, the focus has shifted to the need to dial down the stimulus to allow demand and supply to come into balance.

So, what does 2022 offer? While keeping in mind the saying that there are two sorts of forecasters (those who don’t know and those who don’t know they don’t know) here are five thoughts for the new year.

Governments have two significant motivations to go slow on tightening. The first is that uncertainties remain over when the pandemic will recede as a threat, due to new variants emerging and the uneven development of infections and vaccination worldwide. The second is that sustainably financing the raised levels of national debt ideally requires rapid rates of economic growth and low rates of interest. This is a tricky path to tread but means there is an inbuilt bias to allow economies to “run hot” and a greater tolerance of inflation overshooting than over the past few decades.

Some of the drivers of the recent surge in inflation will fade (such as the rate of change of energy prices and the impact of disrupted trade flows) so inflation rates should trend lower during the year, while remaining higher than in recent years. Hold the hysteria, as this is not unprecedented; inflation rates were high in the years following the 2008 banking crisis and the 1980s were characterised by inflation higher than 4% yet growth was robust. It is mathematically hard to see how holders of government bonds yielding under 2% will avoid long-term real losses with rates so low but equities and other real assets will have a tail wind from the economy, offset by some valuation risk in the areas of greatest enthusiasm.

The overdue drive to combat the effects of climate change and decarbonise economies is leading to significant new growth opportunities as well as threats to the business models of fossil fuel companies. This is a multi-decade opportunity. There is an inflationary side effect (by constraining investment in fossil fuel capacity before renewables can fill the gap) but this should act as a spur to greater fuel economy and innovation.

2022’s consensus growth forecasts are well above long term averages, underpinned by political pressures to spread the benefits of economic growth (levelling up, building back better etc.) together with the front-loading of investment to meet climate change commitments, and residual pent-up demand post lockdown. Near-zero interest rates, and a rapidly growing economy should enable corporate earnings to grow further in 2022 but the benefits will be unevenly spread – some companies will struggle to pass on rises in labour and other costs, while climate change policies and technology will continue to disrupt and produce new winners and losers.

This is the third year when economists have forecast broadening economic growth in the year ahead; 2020’s story was stymied by the pandemic, 2021 saw a brief period of recovery by cyclical stocks, before the Delta variant, uneven growth and supply disruptions led to a rotation back into bonds and growth stocks. The play Waiting for Godot involves a patient audience anticipating an event that, for those still awake, never comes. Waiting for a fully-fledged economic recovery in recent years feels like Waiting for Godot but we believe 2022 will be third time lucky. Assuming that vaccines and treatments mean that Covid moves off the front pages, economic stimulus will be withdrawn only gradually (reducing pressure on the accelerator more than stepping on the brakes). Policies are set to continue prioritising growth but the greater rationing of liquidity will challenge the assumptions in some of the more speculative parts of the markets. This should allow stock picking across a wider range of sectors to enjoy success and reduce the valuation gap between the sectors and markets “on-trend” in recent years and those that have been bypassed.

Andrew Bell, CEO, Witan Investment Trust plc