Reasons for investors to be cheerful and fearful in 2022

Fund managers name tailwinds and headwinds that will influence the direction of stock markets this year.

10th January 2022 10:49

by Kyle Caldwell from interactive investor

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Fund managers name tailwinds and headwinds that will influence the direction of stock markets this year.

It is that time of year when the experts gaze into their crystal balls. We round up why some professionals are optimistic on the prospects for markets, and why others are erring on the side of caution.

Reasons to be cheerful

As it is the start of a new year, let’s start with the positives. The first reason for optimism is the expectation among many commentators that UK inflation will cool in the second half of 2022, as supply chain issues, which have been fuelling the inflation fire, start to ease.

The Bank of England expects this scenario to play out. It states: “Most of the causes of the current high rate of inflation won’t last. Many of them are related to the effects of the Covid pandemic on the economy.

“We expect the rate of inflation to fall quite quickly from the second half of 2022, as the effect of these temporary factors ends. And we expect it to keep falling in 2023.”

Silvia Dall’Angelo, senior economist at Federated Hermes, agrees that inflation will peak in the first half of 2021 and then fall. Her forecast, however, hinges on Omicron or the emergence of other new variants not causing “more protracted supply chain disruptions, which would both weigh on activity and sustain inflation”.

Dall’Angelo notes: “Supply constraints should gradually ease, as the pandemic heads towards endemic equilibrium, supply chains readjust, and supply-demand imbalances lessen. Accordingly, inflation should start a gradual descent after the winter.”

Kristina Hooper, global market strategist at Invesco, expects the Omicron variant to be a negative force in the short run, exacerbating supply chain disruptions and aggravating inflation. Within a few months, however, she argues Omicron is likely to be a positive force if it remains mild.

She adds: “Because it is highly contagious, it appears to be crowding out the more dangerous Delta variant. While I am certainly no epidemiologist, it seems likely to rapidly move through countries, serving as a ‘de facto’ immuniser (far faster than any vaccination programme), which could mean the end of the pandemic by the end of the first half of 2022.”

Grant Bowers, lead manager of the FTF Franklin US Opportunities fund, agrees that inflation will fall, rather than remain at its current high levels. He expects many of the impacts of inflation “to be transitory and moderate in the second half of 2022, as supply-demand imbalances moderate”.

UK inflation is at its highest rate in a decade, having risen to 5.1% in November. Across the pond, US inflation rose to 6.8% in the same month, which is its highest level since 1982.

Not everyone agrees that inflation will decline at some point in 2022. Peter Spiller, fund manager of Capital Gearing (LSE:CGT), argues that investors should brace themselves for a sustained period of high inflation. He explains why below, in the reasons to be fearful part of this article.

The next reason to be cheerful is the potential for the UK stock market to follow up 2021’s double-digit return in 2022. The UK stock market received the most votes from fund managers as the region tipped to outperform in 2022, according to the annual outlook poll by the Association of Investment Companies (AIC).

Over the past couple of years, investors both domestic and international have been shying away from the UK market owing to Brexit uncertainty and the Covid-19 pandemic. This has contributed to UK shares being less expensive than other markets (particularly the US), but experts now argue that the market is becoming too cheap for investors to ignore.

Laura Foll, co-manager of Lowland Investment Company (LSE:LWI), says: “We’re starting from a point where valuation looks quite low, and we also have a decent dividend yield compared to some other markets. So I think that’s a good place to start.”

Sue Noffke, head of UK equities at Schroders, describes the UK market’s cheap price tag as “completely unwarranted”. She adds: “As a result, UK-listed companies continue to be picked off by overseas private equity buyers and overseas industry peers are taking advantage of valuation differentials in a wave of merger and acquisition activity.”

In the final reason to be cheerful, Square Mile, the fund research firm, strikes an upbeat tone for global economic growth.

It says: “We are fairly sanguine about the prospects for economic growth in 2022, expecting it to moderate from 2021’s rebound level but still be solid. As always, however, there are risks and among them we would cite a resurgence of the pandemic, a squeeze on consumer spending caused by higher inflation and, in the UK, higher taxes, or an exogenous event, such a property-related financial shock in China or military conflict.”

Reasons to be fearful

There’s no shortage of headwinds, and with this in mind various commentators argue that investors should brace themselves for higher levels of volatility this year compared to 2021.

First, the Covid-19 pandemic is not over, as evidenced by the emergence of the Omicron variant in late November.

Another risk is the reduction in, and potential end of, quantitative easing in 2022, along with increases in interest rates. Both could lead to a spike in volatility for equity markets, which have benefited from loose monetary policy for more than a decade.

As financial markets have operated in an environment of ultra-low bond yields and interest rates since the global financial crisis, Square Mile adds that “the transition to higher rates, if it comes, could be challenging”.

Peter Spiller, fund manager of Capital Gearing, expects interest rate rises to occur in 2022 as central bankers attempt to contain inflation. However, he thinks the inflation genie is already out of the bottle as wages are also heading up.

Spiller expects inflation to remain at high levels throughout 2022, which he thinks will be welcomed by central banks as a means of reducing some of the huge government borrowing that has taken place in response to the pandemic.

Speaking to interactive investor as part of our Fund Insider video interview series, Spiller says: “We are less optimistic about inflation than the market is generally. Although we fully concede that a lot of the current levels of inflation are driven by shortages of one kind or another as economies re-emerge from Covid-19, there is a real danger in our view that the current levels of increase get embedded in wage increases.

“And then after that we are likely to see substantially high inflation, which after all is what central banks have been asking for and hoping for, for quite a long time. I think they are going to get it, but they might get a little more of it than they really want.”

Spiller, however, does not expect interest rates to return to pre-financial crisis levels any time soon. He points out that the Bank of England does not have a lot of flexibility to raise interest rates significantly due to high household debt levels.

“They are constrained because debt levels are so high. In the UK, you could not see interest rates at 4%, for instance, without the housing market falling over and causing huge banking problems,” he says.

With inflation and interest rates, there’s the added risk of a policy error being made by central banks.

As Square Mile points out: “Do nothing or too little and the inflation genie might well and truly escape its bottle. However, excessive tightening of monetary policy could turn a slowdown in economic growth into a recession and also expose the high levels of debt embedded in the financial system. It is an exceptionally difficult balance to get right.”

The final reason to be fearful is the prospect of the current slowdown in the Chinese economy proving to be structural in nature. Chief among the concerns is China’s overheated property sector, with property giant Evergrande Group (SEHK:3333) teetering on the brink of collapse. The Chinese firm’s liabilities exceed $300 billion.

Gervais Williams, fund manager of Diverse Income Trust (LSE:DIVI), is in the bearish camp. His view is that in common with what happened in Japan in 1989, China’s debt burden combined with its ageing demographics risks halting its growth trajectory.

Williams told interactive investor: “The thing I’m worried about is that Chinese growth is likely to be more moderate. It has been a cornerstone of the global growth over the last 25 years. And if Chinese growth is more moderate, then I think global growth will be more difficult.”

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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