Should investors be CIRCUMSPECT in 2022?

It's been a good year for stock markets, but what will 2022 bring? Our head of markets names the factors which will be central in investors’ minds next year.

Despite the current concerns arising from the latest Omicron variant and the increasingly hawkish noises from central banks on monetary policy, markets have had a strong run in 2021.

At the time of writing, the Dow Jones Industrial Average in the US has risen by 17.5% in the year to date, the S&P500 by 25.5% and the Nasdaq by 21.3%.

In the UK meanwhile, the FTSE100 has added 13% and the more domestically focused FTSE250 11.8% during the year. Now that most FTSE100 companies have returned to paying a dividend, the current average yield of 3.5% can be legitimately added to that number in terms of total return.

Inevitably, this begs the question of whether the froth which has been seen in markets generally this year (the S&P500, for example, has hit record closing highs on more than 60 occasions) is sustainable and whether this rate of progress can be maintained.

In addition, threats which have been an overhang on the technology sector (increased regulation and tax reforms in particular) could affect earnings should these come home to roost.

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With this in mind, our annual acronym as we look ahead, is “Should investors be CIRCUMSPECT in 2022?” and we name the factors which will be central in investors’ minds.

Those factors are as follows –

Consumer

Interest rates/inflation

Rotation

China

US/UK economic recovery

M&A

Strong comparatives

Policy sensitive

Expiration of pent-up demand

Choice: risk assets the only game in town?

Transition to online shopping – how much is here to stay?

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Consumer behaviour will have a noticeable effect on whether companies continue to make progress. In the US, it is estimated that the consumer accounts for some 70% of the overall economy, such that any dents to confidence through further variant outbreaks, economic hardship or continued unemployment could dent the propensity to spend. The UK consumer will have the additional challenge of a tax grab by the Chancellor which will start hitting people in the pocket as the year progresses.

Interest rates (and indeed inflation) are also likely to be central themes. Recent rhetoric from the major central banks have implied that inflation may not be transitory after all, with the Federal Reserve considering an acceleration of its tapering programme, which would leave the field clear to begin raising interest rates in an effort to stem inflation. The cost of borrowing would therefore increase for companies and individuals alike and could have a knock-on effect to profits.

Rotation has been a theme during 2021 and there is little reason to believe that this will change in 2022. Switching between value and growth stocks, and indeed cyclical and defensives, has unsurprisingly tracked prospects for recovering economies. Such rotation has also tended to mirror investor sentiment, with growth stocks such as big tech in particular being the subject of investor interest in more bullish periods.

China is still on course to become the world’s largest economy at some point in the next decade. This year has been marred by events such as those at Evergrande in the property sector, slowing economic growth and increased regulation. At the same time, China’s relationship with the US remains a fractious one and any further mutual sanctions will inevitably both dent sentiment and limit increases in the amount of trade between them.

The US and UK economic recovery will also have a major say in fortunes. There have been instances of pent-up demand being released when restrictions were lifted, a “feel good” factor on a commercial and social basis, and some kind of return to normality. Less positively, recent supply chain blockages are choking supplies, raw material prices are therefore rising and inflationary pressure is becoming entrenched. At the same time, accommodative monetary policy and government help schemes (such as the furlough in the UK) are coming or have come to an end, leaving economies to stand on their own feet for the first time in quite a while.

Merger and Acquisition activity has also been a driver this year, particularly notable in the UK where companies have been approached and/or purchased not only on valuation grounds – the UK is still seen as relatively cheap compared to many of its developed market peers – and a continuation of this theme next year remains possible. This in turn would be positive for sentiment on the basis of investor optimism on future prospects.

Strong comparatives also need to be borne in mind. In each quarter of the year to date, corporates on both sides of the pond have not only smashed expectations but have shown signs of considerable growth “on the ground”. Of course, this means that company earnings will need to maintain this level of growth to assuage investors in the coming year, with any disappointments, or “misses”, likely to be punished. Earnings stability – and pricing power - could well prove essential against a backdrop which may be very different to this year.

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Further threats could come from markets which will be policy sensitive (especially if governments and central banks are seen to be behind the curve) and from the expiration of pent-up demand if and when economies normalise.

On the other hand, in terms of choice, TINA remains in many investors’ minds – There Is No Alternative. With virtually no return on cash and with wafer thin yields on bonds, for many equities remain the investment destination of choice.

And, should normality return during the year, how much of the transition to online shopping is here to stay? Has consumer behaviour now changed for the long-term, which would pile further pressure on the future of the high street, and the traditional employment model as many choose the hybrid method of physically being in the office as well as working from home in a typical week. The effects of the pandemic could have a lasting impact on all manners of societal, and to some extent, investing, behaviours.