The coming year presents a complex picture as the global economy finds itself on an uncertain climb toward recovery.

Key points

• Global economic recovery from COVID – lowest hanging fruit already harvested
• Central banks to increasingly jump on the rate-hike bandwagon in 2022
• China growth rate forecast downgraded to just 5%, but investment case remains intact
• European equities in a sweet spot & a better prospect than US share markets
• The transition to a low-carbon economy a multi-dimensional shock event
• A mass displacement of fossil fuels by renewables could come sooner than expected

Highlights

2022 outlook

The current economic recovery will continue to deliver above-potential global growth.

The global growth narrative is far from uniform. In emerging markets (EM), growth headwinds persist as lagging vaccination levels, rising interest rates, electoral uncertainties, and other domestic policy considerations take their toll. In China, we have downgraded 2022 growth expectations to just 5.0% and still see near-term risks skewed to the downside.

One cannot overstate the importance of vigilance in continuing the COVID fight at this stage of the business cycle. This is because the lowest-hanging “re-opening” fruit has already been harvested, and the gains that come next will be harder-won and more modest. 

The concerns that will accompany the removal of fiscal and (especially) monetary policy accommodation will become more prominent by the middle of 2022.

The twin dynamics of high growth and high inflation that dominated the macro narrative in 2021 will extend into 2022. However, while inflation steadily built over the course of 2021, it should steadily decline from mid-2022 onward.

It is worth considering more broadly whether a combination of highly accommodative macro policy, rising production costs in a scenario of “peak globalization,” new costs associated with the green energy transition, and renewed global focus on equitable growth and income redistribution will create a fertile ground where persistently higher rates of inflation might take root.

Expect developed markets’ central banks to jump on the rate-hike bandwagon in increasing numbers over the course of 2022. 

Equities market outlook

The coming year presents a complex picture as the global economy finds itself on an uncertain climb toward recovery.

Increased volatility is also looming, as equities markets rise and fall in response to the ebb and flow of the global pandemic, and in response to policy signaling.

Corporate earnings have surprised to the upside, and — perhaps even more importantly — forward guidance for 2022 has been strong. We believe companies are in a good position to deliver on that guidance.

US stocks have led global equity performance for years – but we think Europe will pull ahead in 2022. In the search for reasonable bargains and strong return potential, we think European equities will represent a find in the coming year.

With earnings growth in Europe now expected to outstrip the US, we think equity markets are poised to catch up.

A wave of infrastructure spending, exemplified by the recent passage of a $1 trillion infrastructure bill in the US, will benefit cyclical sectors including industrial, materials, energy, and financial firms.

For equity investors, commodity sectors and cyclicals represent the best hedge against inflation, while higher background volatility can be mitigated by managed-volatility and defensive equity strategies.

ESG investment theme

Investors should think of the transition to a low-carbon economy as a multi-dimensional shock event, spread out over time, which will have major regulatory and economic consequences and profound investment implications.

Recent events, country-specific incentives, and multiple positive feedback loops are setting the stage for faster movement toward decarbonisation in 2022 and beyond.

Positive feedback loops underpinned by innovation will likely lead to a mass displacement of fossil fuels by renewables — potentially much more quickly than many would anticipate.

A massive economic depreciation exercise for carbon-heavy assets, alongside an appreciation exercise for carbon-neutral assets, is looming, and this situation will present risks as well as opportunities.

Government fiscal policies to help build sustainable economies could also lead to company balance sheet damage from tax increases, even if these tax hikes are shared with households.

Time to reconsider your China exposure

The macro rationale for China investment remains intact. While the country’s growth trend is decelerating, its growth rate will remain far above that of developed markets.

Even if annual GDP growth were to slow to a persistent level of 4% to 5%, this would provide a lot of room for companies to grow their earnings at an attractive rate. Moreover, China’s size means that its companies can take advantage of a larger home market.

The country remains a large net creditor, and its unique political system means that it has built up a sizable capital base in the form of hard and soft infrastructure.

China’s equities market appears structurally undervalued. China’s equities-market capitalization is stuck at 82% of GDP, far below that of any developed market.

We estimate that market-cap-to-GDP should reach 100% by 2025, driven by new stock issuance and the growth of the current market. In addition, cyclical markers also indicate excessive discounting.

Chinese assets retain very low correlation to other markets and maintain excellent diversification features. The pandemic illustrated how much China follows its own economic cycle and its own policy priorities. Limited integration with global financial markets also helps to reduce correlation with other markets.

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