Interactive Investor

Bull and bear points for major equity markets at start of 2022

5th January 2022 10:19

David Prosser from interactive investor

A range of professional investors give their views on prospects for the UK, US, Europe, Japan, emerging markets and Asia in 2022. 

If 2021 has been a year of volatility and uncertainty for global stock markets, then expect 2022 to bring more of the same. Equity prices certainly have the potential to move higher – but there is a long list of downside risks to worry about.

Bull points

The big picture is that the economic backdrop is supportive. The International Monetary Fund (IMF) predicts the global economy will expand 4.9% over 2022, following a 5.9% recovery in 2021 from the previous year’s Covid-19 recession; that is comfortably ahead of trend growth over the past two decades.

To add to that sense of positivity, there is no sign of the key structural drivers that have been driving markets higher in recent times running out of steam. With interest rates low around the world and an ageing population needing to fund retirement – at least in advanced economies – demand for the type of returns that only stock markets tend to deliver remains very strong. And for all the talk about growth stocks’ inflated valuations, the technology sector in particular continues to generate the cashflows that these valuations imply.

Bear points

However, before investors get carried away, there is also a downside case to consider. Most obviously, the Covid-19 pandemic is not over. The emergence of the Omicron variant is already causing huge disruption in many countries – and investors are easily spooked; news of the variant wiped as much as 3% off many markets on the day it emerged.

Then there is the threat posed by tighter monetary policies. The US Federal Reserve is finally moving towards tapering the huge stimulus it has provided to the US economy, much of which has found its way into equity markets. Policymakers around the world, including in the UK, are beginning to raise interest rates. One reason for that is the re-emergence of inflation. The soaring cost of raw materials, of labour, and of logistics, all threaten corporate profitability.

The outlook is, in other words, decidedly mixed. “Despite the 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,” says Richard Hunter, interactive investor’s head of markets. “Inevitably, this begs the question of whether the froth which has been seen in markets generally this year is sustainable; investors should be circumspect.”

Where does that leave individual markets and regions. Here’s what the experts think.

UK

While all of those global threats certainly apply in the UK – a new wave of Covid-19, soaring inflation and rising interest rates – something is different too. “UK shares remain cheap because of the perceived significant political and economic risks of Brexit, which continue to linger and depress the valuation of the UK stock market,” argues Sue Noffke, head of UK equities at asset manager Schroders. “We believe the extent of the valuation discount is completely unwarranted.”

There is no disputing the diagnosis. Remarkably, UK equities currently trade at a 40% discount to global peers, a wider gap than at any time in the past 30 years. Still, the problem with valuation opportunities is that there is no knowing when the market will close the gap.

Still, fund managers are hopeful. “We believe UK equities present opportunities for a catch-up trade,” argues Martin Walker, head of UK equities at Invesco. He argues that the efforts of companies’ to focus on cash flows at the height of the Covid-19 crisis last year are now paying off, generating higher returns on equity than prior to the pandemic; earnings estimates for UK companies for the next 12 months have risen significantly more quickly than in other markets.

Europe

In recent months, the MSCI Europe Index has delivered its best performance relative to the rest of the world for 20 years, but Morgan Stanley analysts believe this can be sustained into 2022. Rising M&A activity across the continent and increased demand from global investors that have underweighted European stocks in recent times provide reasons to be positive.

“Our combined earnings and valuation assumptions suggest that European stocks can deliver an 8% price return and double-digit total return,” says Graham Secker, Morgan Stanley’s chief European equity strategist. His colleagues pick out the auto, energy and financials sectors as being particularly attractive.

Such bullishness is not confined to Morgan Stanley. One recent poll of 23 fund managers, strategists and brokers conducted by Reuters suggest European markets could hit record highs in 2022, with predictions of an 8% and 6% rise for German and French equities respectively.

Still, the optimism is not universal. One strategist in the poll, Stephane Ekolo, of brokerage Tradition, predicted a year in the red for European equities as a whole.

“Corporate earnings are likely to deteriorate over the coming six months on the back of continued supply-chain disruptions, reopening boost fading, potential risk of restrictions and rising real interest rates,” he warns.

US

"The equity bull market will continue," says David Kostin, chief US equity strategist at Goldman Sachs. However, other markets may deliver better value. “Decelerating economic growth, a tightening Federal Reserve, and rising real yields suggest investors should expect modestly below-average returns next year,” he warns.

Analysts at Morgan Stanley are also cautious, given the strong performance of US equities over 2021, which might see attention shift to a catch-up from other markets over the year ahead. Michael Wilson, the bank’s chief US equity strategist, thinks American companies can continue to grow their earnings in 2022. But he warns: “Uncertainty around that expectation goes up materially given cost pressures, supply issues, along with the tax and policy uncertainty that is unique to the US.”

Certainly, President Joe Biden has plans for tougher tax policies, with the aim of raising an additional $1.5 trillion from wealthy Americans. And while the president has rejected suggestions that he is planning any kind of tax raid on middle income earners, any negative impact on US consumer confidence would be damaging, given that the US consumer sector accounts for as much as 70% of the country’s economy. Many households’ disposable income is already under pressure from rising inflation, which hit 6% in November.

Japan

Tough government action on Covid-19 since surging case numbers coincided with the Olympics in the summer has left Japan in a comparatively strong position to cope with the Omicron variant, argues Ken Maeda, head of Japanese equities at Schroders, who points out that nearly 80% of the population were fully vaccinated by the end of November.

“Prior success in containing the virus allowed the government to lift most domestic pandemic restrictions at the end of September,” says Maeda. “While Japan has already benefited from the broader global economic recovery, we should now see the domestic economy reopen and recover.” That could help small- and mid-cap stocks in particular, he suggests.

More potential support for Japanese equities comes from the new stimulus package recently unveiled by the government, under new prime minister Fumio Kishida (pictured below). Worth $490 billion, it includes cash handouts for households with children, as well as for students and those on low incomes, plus subsidies and tax breaks for small businesses.

At Invesco, chief investment officer Daiji Ozawa is also upbeat. “Japan should benefit from a post-pandemic resumption in capital expenditure plans globally, given its relatively large exposure to the capital goods sector,” he says. “The pandemic has sped up digitalisation and automation shifts, and in our view, this should translate to sustained earnings growth, especially among leading factory automation names.”

Asia

All eyes are on China, as growth in the world’s second-largest economy sags courtesy of a downturn in the debt-fuelled property sector. The country’s leadership, who might have been expected to intervene, are attempting to rebalance the Chinese economy and may therefore be prepared to put up with short-term pain; regulatory interventions in sectors including technology, education and financial services during 2021 underline that determination.

Amid such uncertainty, Chinese equities have been volatile over the past 12 months, with investors often appearing to be spooked. Still, Vincent Che, a fund manager at Ping An Asset Management, thinks those who hold their nerve will be rewarded.

“We believe recent turbulence has been driven by panic, rather than changing fundamentals, and we continue to believe that the outlook for China is bright,” Che argues.

He adds: “Bouts of volatility are not unusual in emerging markets, so it’s important to look through the noise and negative headlines.” Those who do will find attractive opportunities as China’s economy moves into a new phase, he suggests, with demand for higher quality goods and services increasing, and innovation still impressive.

Still, other analysts see more exciting opportunities elsewhere in Asia. For example, Ridham Desai, Morgan Stanley’s equity strategist head, recently published research suggesting Indian equities could deliver returns as high as 16% over 2022.

At Schroders, Toby Hudson, head of Asian ex Japan equity investments, notes the attractions of more developed Asian markets. “Some of the best companies in Asia are listed in Australia, Taiwan and Korea,” he argues. “We could point to global leaders in healthcare, semiconductor manufacturing, batteries, or niches like bicycle manufacturing.”

Emerging markets

In a year when developed economies have benefited from superior access to vaccines and more robust healthcare systems, emerging market equities have failed to keep pace. The MSCI Emerging Markets Index fell 17% from its peak in February to the end of 2021.

The outlook is problematic, warns Victoria Scholar, head of investment at interactive investor. “Emerging markets with lower vaccination rates are more likely to be at risk from the Omicron variant; countries with the lowest percentage of the population at least partially vaccinated include Russia, India and Mexico,” she warns.

“In addition, the strengthening US dollar, underpinned by monetary policy normalisation from the Federal Reserve is likely to be a key risk to emerging markets in 2022.” Those countries with higher dollar-denominated debt levels and current account deficits are particularly exposed, Scholar explains.

Still, there are some optimists. At Jupiter Asset Management, head of strategy for global emerging markets Nick Payne points out that emerging markets are beginning to catch up on vaccinations. He says: “Shopping centres in Indonesia have been filling up again; Thailand reopened to tourists at the beginning of November; Vietnam reopened its largest island to tourists in late November.”

In Latin America, meanwhile, rising commodity prices represent a tailwind for several markets. “The cyclical story in Latin America is solid: strong commodities, a recovery in beaten-up currencies, and a cyclical improvement in US dollar earnings,” argues Justin Leverenz, senior portfolio manager at Invesco. “The structural story is perhaps even more important: the rise of disruptive technology could help underwrite a better chapter for the region, and represent a big opportunity for investors.”

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