As the world continues to grapple with the effects of COVID-19, Robert Jenkins analyses the economic prospects for the coming year.
- With COVID-19 endemic around the world, the 2022 investment investment environment appears superficially similar to 2021.
- A stronger performance from value stocks has implications for tech stocks, and Facebook and Tesla may not be as resilient.
- Inflation and central bank policy will pressure 10-year U.S. Treasuries upward – but not above 2 percent.
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Hunkered down at home this time last year and pondering how 2021 might play out, it was clear that the great unknowns of the pandemic would likely dictate and even drastically alter even the best predictions.
However, there were patterns and new axioms already emerging in terms of the ebb and flow of the virus, and the economic reactions to it that one could cling to when looking ahead.
Among those trends are the seasonal waves accompanying indoor-versus-outdoor activity and the shifts in behaviour and sentiment that ebb and flow with them.
There were also the very real impacts of changes in work, travel, leisure and consumer spending behaviours that may well linger beyond COVID-19 becoming endemic. These were the ballasts I looked to last year and they continue to play out looking to 2022, but with a few new twists – in particular, the availability of vaccines and other effective treatments to combat COVID-19.
For more on this topic, read Robert’s Lipper Alpha blog
Lingering economic impact of COVID-19
So now, as we move into 2022, the one thing we can say for sure is that the Coronavirus will continue to factor in the global economy as each new wave and variant arises.
The economic impacts will bear many of the traits we’ve seen since late 2020 – a perfect storm for increasing inflation and market leadership changing between growth and value/cyclicals as sentiment swings between lockdown fears and reopening cheers.
At the end of the year, we will likely see overall economic growth, albeit at a slower pace than 2021, as the world overall has become more adept at managing the virus. No doubt there will be further COVID curveballs that will cause havoc along the way.
At a high level, the recent variant will likely lead to stubborn inflation persisting in most major global economies.
The massive stimulus of the past 20 months has left a trail of savings and liquidity that is primarily being put to work buying consumer goods, with decidedly less being pointed at services such as travel, entertainment and dining out.
This lopsided demand keeps the pressure on an already constrained supply chain which, in turn, keeps inflation high.
Any sort of new wave in the virus will further pump-up inflation as more people opt not to work and choose to stay home and shop online. These collective pressures on global inflation will force central banks to act, and only a severe COVID-19 retrenchment will counteract the anticipated tightening.
This time last year, I felt inflation would definitely pass the 2-3 percent range which, given recent history, was actually a bit bold. I never thought we’d see 6 percent headline prints in the U.S., but I suspect we’ll see those numbers tick down into the 3.5 percent – 4.5 percent range this year and the eventual rate of change should start to stabilise by this time next year.
Soaring energy prices
Last autumn, I posited that energy prices would rise into the $70-75 range in the second half of 2021 as the economy opened up and travel began to resume.
We did in fact see that and now are dealing with relatively high energy prices the likes of which haven’t been seen since 2014.
Multiple forces will provide support to higher energy prices: supply chain issues, political posturing, demand for heating/cooling due to climate change, etc. However, COVID-19 will occasionally step in and disrupt and counteract these forces to keep oil somewhat rangebound in the $70-$80 range and occasionally dipping down into the $60s.
Travel will continue to be a wild card next year and business travel, on the whole, may never return to pre-COVID levels
U.S. Treasuries defy economic logic
A perennial prediction of mine over the past seven to eight years is the stubbornness of rates on the 10-year Treasury. It continues to defy expectations and logical economic relationships.
Since it is somewhat of an old friend due to its reliability, I’m sticking with it again.
Last year, I suggested rates would rise from the ridiculously low levels they dipped to, but would stop out between 1.3 percent and 1.5 percent.
This coming year, inflation and central bank policy will no doubt pressure those rates upward again, and I expect the 10 yr to range between 1.5 percent and 1.8 percent but likely remain below 2 percent.
This will be due to several factors: the global demand for yield, intermittent rushes to Treasuries as a safe haven from COVID-19 and other shocks, such as climate, as well as ongoing fund flows and asset allocation activities.
How will the markets react?
All these factors will also likely lead to slowing global growth but, that said, inflation may also lead to pricing power and expanded margins and earnings.
These positives from inflation coupled with the continuing strength of the consumer will help buoy the markets and provide a partial offset to the pricing pressures that growth stocks in particular will likely feel in a rising rate environment.
As a result, growth and value will likely continue their 2021 dance for leadership, with value destined to come out on top – barely.
Growth names not supported by strong earnings will be under pressure, while value and cyclicals lurch ahead. That said, what I consider the Big 5 – Microsoft, Google, Apple, Amazon and Nvidia – will continue to shine despite all being richly valued growth stocks.
They have begun to attain a status as a safe haven and their earnings generally continue to be strong, so there is a consistent and dependable aspect to them that draws investors.
Also, to note, these stocks populate immense amounts of passive and retirement plan AUM, which means they have steady flows into them in almost any economic environment.
I don’t think Facebook (META) and Tesla will be as resilient.
Overall, be prepared for muted stock returns in the upper single to low double digits and flat to negative total returns on bonds.
Stay the course, avoid the temptation of trading market swings and, most importantly, have a happy new year!