Livewire has acquired Market Index, the country’s leader in free stock market data.
Find out why.

2022 Global outlook - Omicron update

Nathan Lim

Morgan Stanley Wealth Management

Morgan Stanley believes we are currently well into the middle of this current economic cycle, with our US cycle indicator now in the expansion phase (see Exhibit 1). Nineteen months have passed since the end of the COVID-19 recession, the shortest US recession ever, which lasted just two months from February to April 2020.

Moving forward, Morgan Stanley has six key views regarding the global outlook:

  1. Inflation is transitory.
  2. Global growth will remain above trend.
  3. Central banks will raise interest rates much slower than current market pricing.
  4. The new COVID variant Omicron, at least for now, is expected to have a limited impact on Morgan Stanley’s global growth forecasts.
  5. Australia is doing well.
  6. We continue to prefer Equities over Fixed Income.


Exhibit 1 – Morgan Stanley US Cycle Indicator well into “Expansion"

Source: Bloomberg, Haver Analytics, Datastream, Morgan Stanley Research.

Inflation is transitory

At this stage in the economic cycle, inflation is the key concern for markets given its influence on interest rates. Essentially, if inflation escalates, interest rates in general will surge in a similar fashion - leading to defaults and ultimately an end to the cycle. There are four broad sources of inflation, most of which we believe are transitory, but not all (see Exhibit 2).

Exhibit 2 – Some higher prices will remain but direction of travel is generally down over time

Source: Morgan Stanley Wealth Management Research

In terms of wage inflation, this has been impacted by people choosing not to work given the COVID-19 associated direct government payments supporting household income. With the end of these direct payments and lockdowns, we expect individuals to return to the workforce, and therefore the pressure to fill employment positions is likely to ease.

Inflation associated with physical goods has also been impacted by these direct government payments. For example, since April 2020, US furniture prices have risen around 30% and used car prices have increased around 40%. However, with mobility returning to society, households are shifting their consumption back towards services. The delivery of movies, meals, and experiences should alleviate pressure on physical supply chains and generally lead to price declines in physical goods.

Commodity prices have also similarly risen sharply. Since the recent recession's end, economic activity has accelerated and supply has not kept up. However, Morgan Stanley believes that most commodities (including the base metals - in particular, copper and zinc) will likely move back into oversupply situations next year, which should also lead to outright declines in commodity prices. However, iron ore is a notable exception as Morgan Stanley believes prices have likely bottomed and should be supported by improved trading conditions in China in 2022. We see iron ore averaging US$95/tonne in 2022.

Regarding energy prices, natural gas prices have already started to roll over. After rising around 1500% since April 2020, the benchmark Dutch natural gas price has retreated. Russia has started to inject gas back into the European system, where we see inventory levels largely back to long term average levels. Oil is another key exception to our theme of falling prices. In the near term, OPEC+ supply management and surging global economic activity underpins oil prices. In addition, based on a more secular basis, Morgan Stanley has observed that industry capital expenditure in 2020 fell to ~$350 billion (after reaching ~US$475 billion in 2019). In 2014, this investment stood at ~US$740 billion. According to the International Energy Agency's (IEA) 2050 global net-zero scenario, the oil and gas industry will still need to spend ~US$365 billion over the next decade to meet demand at that future point. As first production can be decades after making the initial capital investment, we believe the industry is positioning for a net-zero future, despite demand currently looking nothing like it. For example, in Norway, where electric vehicles account for ~70%+ of new car sales, the demand for diesel and gasoline has remained flat for the past five years (see Exhibit 3). Morgan Stanley is not suggesting oil demand will not change, rather we believe supply should peak before demand - leading to upward pressure on prices.

 Exhibit 3 – Norway auto gasoline and diesel sales (ML) have remained flat, despite electric vehicles accounting for ~70%+ of new car sales

Source: Norway SSB Statistics.

Overall, however, inflation is a "rate of change" measure meaning prices have to rise substantially once again to become problematic. For example, used car prices would need to increase another ~40% to repeat the same undesirable impact on inflation, and we believe this scenario is unlikely. Accordingly, Morgan Stanley expects global inflation to peak over the next 12 months and, for the US market, we see Core PCE inflation peaking over the next few months.

Exhibit 4 – Inflation to peak

Source: IMF, Morgan Stanley Research forecasts. Note: Global aggregates for inflation is PPP-based GDP-weighted averages, using PPPs; CPI numbers are period average. Global consumer price inflation aggregates exclude Argentina; Japan CPI includes impact of VAT and free child education.

Growth above trend over forecast horizon

Morgan Stanley's global growth forecasts continue to be well-above consensus forecasts. We have observed strong business investment in the US and the larger Emerging Market countries (Brazil, Russia and India), which has led to the fastest cyclical recovery in business investment since the 1940s. This investment has focused on manufacturing machinery as well as IT-related equipment and software. Similarly, consumption remains robust - supported by fiscal payments - leading to households globally mostly holding significant levels of excess savings. For example, for the US, Australia, China and Europe we estimate excess savings as a percentage of GDP at approximately 10%, 10%, 5% and 4%, respectively.

Exhibit 5 – Global GDP Growth Forecasts

Source: Haver Analytics, Bloomberg, IMF, national sources, Morgan Stanley Research forecasts; Note: The global aggregate is a weighted average using GDP (PPP) weights. Cons = consensus.

Europe and Japan remain our preferred regions. Generally, individuals returning to work are supporting household incomes. Furthermore, ongoing COVID stimulus payments should help Europe's steady economic rebound, while Japanese exporters should continue to be direct beneficiaries of the surge in corporate investment.

The "Great Inventory Build" and fiscal stimulus should also assist the US. Morgan Stanley estimates that over the past 18 months, US inventories have fallen by ~US$1 trillion, with ~40% of that concentrated in the automobile industry. This normalisation in supply chains, along with the shift in spending towards services and companies relaxing Just-in-Time practices, should drive a build-up in inventory levels. Morgan Stanley sees the restocking of inventories as adding 0.8% to US GDP growth in 2022 on a 4Q/4Q basis. We still also believe the Build Back Better legislation will be passed before year-end, contributing to deficit expansion and supporting growth.

We believe an imminent policy pivot will occur in China. China has focused on reforms which unfortunately have brought negative economic consequences. Prioritising decarbonisation and clean air has led to chronic power shortages, while removing financial leverage from the property sector resulted in sales falling materially - with construction activity following closely behind. Furthermore, regulations on corporate behaviour and ensuring data security have impacted the technology sector. Lastly, the zero-COVID policy has nearly eliminated the virus nationally, but the sudden lockdowns have impacted the economy. Morgan Stanley believes over the coming months, credit will flow more freely into infrastructure and manufacturing investment, in turn supporting a rebound in economic activity moving into 2022.

Exhibit 6 - GDP growth to reach 5.5%Y in 2022 amid policy easing

Source: CEIC, Morgan Stanley Research

Markets are mispricing when major central banks will increase interest rates

Given our view on inflation and global growth, Morgan Stanley believes major central banks will not raise interest rates as fast as the market is pricing (see Exhibit 7), in turn leading to yield curve steepening. For example, looking at the US, by the end of 2022, we see the Federal Fund Rate (which is the overnight rate) still near zero while the US Government 10 Year Bond rate will be at 2.1%. A steepening yield curve is consistent with the mid-cycle as the general interest rate environment should be rising as the cycle matures.

It is important to note that the neutral Federal Fund Rate is 2.5%, meaning monetary policy must exceed this level before it becomes a headwind to economic growth. Coupled with our view that global growth will remain above long-term trend growth, we believe there is more upside to this cycle.

Exhibit 7 – First central bank interest rate increase: Morgan Stanley versus Market Pricing

Source: Haver Analytics, Bloomberg, Morgan Stanley Research forecasts. Market pricing for the first interest rate increase as at 26 November 2021.

Omicron impacts are limited for now

In assessing the impact of the new COVID variant Omicron, we are watching for details on its transmissibility and impact on vaccine efficacy as well as on hospitalisations and mortality rates. Should this new COVID variant turn out to be more transmissible than the Delta variant, it could pose lockdown risks in Asia. However, Morgan Stanley’s biotechnology analysts point out that the emergence of the C.1.2 variant several months ago raised the same risk. This variant was initially believed to have a 15% transmission advantage over the Delta variant, but today it still represents <5% of cases in South Africa.

Vaccine manufacturers have already started to test their vaccine efficacy against this new variant. Our biotechnology analysts expect that it will take ~2 weeks before initial results are out.

The economic impact from Omicron might not be as severe as the consequences of the Delta outbreak given in recent months policymakers have tended to rely more on targeted and selective lockdowns rather than full lockdowns. This action is supported by the generally higher levels of vaccination.

The overall economic impact will likely vary by region (see Asia Economics: Assessing the risks from the new COVID variant, 28 November 2021) but our view is that the impact on fourth quarter 2021 GDP should be limited as this is a new variant and the starting point of cases is relative low. The risks are more prone towards the first quarter of 2022 as well as dependent on the evolution of the Omicron outbreak.

Australia is doing well

In this global context, Australia continues to do just fine. There has been limited impacts to the economy due to the lockdowns in Victoria and New South Wales, and Morgan Stanley has upgraded our 2022 GDP forecast to 4.4%. We believe corporate investment will return after a promising trend before the lockdowns. The easing of international borders is another source of growth as net migration has traditionally been a strong growth driver. Before COVID, net migration contributed about half of Australia's long term trend growth. We also expect the Australian dollar to reach 79 cents against the US dollar by the end of 2022. We have a differing view to the market regarding the US Federal Reserve's monetary policy pathway, which we believe is likely to lead to US dollar weakness in the back half of 2022 - and thus a stronger Australian dollar.

Positioning

We have a constructive view on equities for the next 12 months but have moved back to neutral tactically given rising short term uncertainty. Omicron is also contributing to these short term risks. Within Equities, we have a relative preference for International (specifically Europe and Japan) over Australia. At a sector level, we prefer Healthcare, Financials, REITs and reasonable priced secular technology companies. We prefer the Vanguard Global Value Equity Active ETF (VVLUE), Vanguard FTSE Europe Shares ETF (VEQ), Betashares Japan ETF (HJPN), VanEck MSCI World ex-Australia Quality ETF (QUAL) and Capital Group New Perspective Fund (APIR: CIM0006AU).

We are underweight Fixed Income, but notably continue to prefer lower quality corporate debt over long-dated government debt. That said, we continue to remind investors that despite their low yields, a well-diversified portfolio should still include an allocation to long-dated, high-quality bonds as they help manage overall portfolio risk during periods of unexpected volatility. For corporate debt, we prefer high income floating rate debt, with loans the most attractive. We prefer the Vanguard Australian Government Bond ETF (VGB), Pendal Sustainable Australian Fixed Interest Fund (APIR: BTA0507AU), and the Bentham Global Income Fund (APIR: CSA0038AU).

Learn more

Please click 'Contact' if you would like a copy of the full Morgan Stanley report.

Specialist advice from Morgan Stanley

Morgan Stanley Australia focuses on providing individuals and institutions with specialist strategic advice and then helping implement these strategies through superior investment execution. For more of my insights, follow me here.

........
The information and opinions in Morgan Stanley Wealth Management Research were prepared by Morgan Stanley Wealth Management Australia Pty Ltd (ABN 19 009 145 555, holder of Australian Financial Services License No. 240813) ("Morgan Stanley Wealth Management"), and Morgan Stanley Wealth Management takes responsibility for the production of this report. Morgan Stanley Wealth Management’s Research Department produces and distributes research products for clients of Morgan Stanley Wealth Management. This Morgan Stanley Wealth Management Research is disseminated and available only in Australia. For important disclosures (including copies of historical disclosures) regarding the securities and/or companies that are the subject of this Morgan Stanley Wealth Management Research product, please contact Morgan Stanley Wealth Management Research, Level 26 Chifley Tower, 2 Chifley Square, Sydney NSW 2000, Attention: Research Management. In addition, the same important disclosures, with the exception of the historical disclosures, are contained on the Firm's disclosure website: https://www.morganstanley.com/online/researchdisclosures Historical disclosures will be provided upon request back to June 1, 2009. In addition, please contact us if you require Morgan Stanley Wealth Management Research model portfolio performance figures for previous periods. Global Research Conflict Management Policy Morgan Stanley Wealth Management has a Conflict Management policy available at: https://www.morganstanley.com/online/researchconflictpolicies Morgan Stanley & Co. LLC Stock Rating System & Definitions For an explanation of Morgan Stanley's Stock Rating system and definitions, please refer to Morgan Stanley Wealth Management’s disclosure website: https://www.morganstanley.com/online/researchdisclosures Hybrid and Convertible Securities Rating System and Definitions The value of hybrid and convertible securities can be impacted by a number of events including but not limited to movements in credit spreads, secondary market liquidity, and relative attractiveness of hybrid returns versus other asset classes. Significant event risk can also impact the value of hybrid and convertible securities. These include, but are not limited to credit adjustment by rating agencies, underlying entity fundamentals, changes in the tax and or regulatory environment, solvency issues surrounding the underlying entity and changes to the duration or maturity date. For a large number of investment grade securities, the rights to redeem, convert, change, and/or extend the terms lie with the issuer and not the holder of the security. Morgan Stanley Wealth Management cannot make an assessment on potential changes to terms until they have been announced by the issuer. Neither the capital value nor the distribution income of hybrid or convertible securities is guaranteed. In an event of default, hybrid securities may rank ahead of equity holders but behind debt holders in the winding up of an entity. For full terms & conditions of each hybrid or convertible security, including specific risks related to each security, refer to the prospectus or product disclosure statement available from your Financial Adviser. Morgan Stanley Wealth Management Research does not necessarily cover the underlying equity securities for hybrid and convertible securities mentioned in this report. Investment Risk Rating: Morgan Stanley Wealth Management’s hybrids and convertibles risk ratings assess the risk of each security based on a number of quantitative and qualitative factors, including the financial strength of the issuer, debt/equity ratio of the issuer, interest cover of the issuer, the issuer’s ability to pay distributions, conversion risk, dilution risk of conversion into equity, and duration risk. Risk ratings assess both the risk of the issuer and the specific risk of the actual security. An issue can be rated high risk for example, despite the issuer being of sound financial health, due to security specific terms which are security holder ‘unfriendly’, or there is a high degree of uncertainty (and therefore “redemption value”) on the exit and/or conversion conditions. Each security will then be given one of four ratings: Low Risk – a security is backed by an entity that has strong capacity to meet its financial obligations and commitments. The risk of the entity missing a distribution payment is considered low. Medium Risk – a security is backed by an entity that exhibits adequate protection parameters, however, adverse economic conditions or changes in circumstances could lead to a weakened capacity of the entity to meet its financial obligations. High Risk – a security is backed by an entity that is more vulnerable to adverse economic conditions which may lead to distributions being lowered or cancelled. A security may also be considered High Risk when the outcomes surrounding the maturity date are largely unknown. Speculative Risk – a security is backed by an entity that is highly vulnerable to adverse economic conditions. An entity may also be showing signs of financial stress. There is a high degree of uncertainty surrounding the entity’s ability to make a regular distribution payment. The research analysts or strategists principally responsible for the preparation of Morgan Stanley Wealth Management Research have received compensation based upon various factors, including quality of research, investor client feedback, competitive factors, and firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues). Research analysts' or strategists' compensation is not linked to the profitability or revenues of particular capital markets transactions performed by Morgan Stanley Wealth Management or the profitability or revenues of particular fixed income trading desks. Morgan Stanley Wealth Management and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Wealth Management Research. Morgan Stanley Wealth Management and/or its affiliates sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Wealth Management Research on a principal basis. This communication has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein is not intended to constitute investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To the extent this communication is deemed to contain any general financial advice, such advice is prepared without taking account your objectives, financial situation or needs and because of this, you should, before acting on the general advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If the advice relates to the acquisition of a particular financial product for which a product disclosure statement or other disclosure document (‘offer document’) is available, you should obtain the offer document relating to the particular product and consider it before making any decision whether to acquire the product. Morgan Stanley Wealth Management recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Wealth Management Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisers do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal adviser for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation. Morgan Stanley Wealth Management Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The important disclosures contained on the Firm's disclosure website at: https://www.morganstanley.com/online/researchdisclosures list all companies mentioned where Morgan Stanley Wealth Management or Morgan Stanley & Co. LLC owns 1% or more of a class of common equity securities of the securities/instruments of companies. Morgan Stanley Wealth Management or its affiliates may trade securities/instruments or derivatives of securities/instruments in ways different from those discussed in Morgan Stanley Wealth Management Research. Employees of Morgan Stanley Wealth Management not involved in the preparation of Morgan Stanley Wealth Management Research may have investments in securities/instruments or derivatives of securities/instruments of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Wealth Management Research. Morgan Stanley Wealth Management Research is based on public information. Morgan Stanley Wealth Management makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Wealth Management Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views presented in Morgan Stanley Wealth Management Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley Wealth Management business areas, including investment banking personnel. The value of and income from your investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realised. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company's securities/instruments. Morgan Stanley Wealth Management and its affiliates may make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. The trademarks and service marks contained in Morgan Stanley Wealth Management Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. Morgan Stanley Wealth Management Research, or any portion thereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Wealth Management. Morgan Stanley Wealth Management Research is disseminated and available primarily electronically, and, in some cases, in printed form. This report was prepared solely upon information generally available to the public. No representation is made that it is accurate and complete. Additional information on recommended securities/instruments is available on request. © 2021 Morgan Stanley Wealth Management Australia Pty Ltd

1 contributor mentioned

Nathan Lim
Head of Wealth Management Research
Morgan Stanley Wealth Management

Nathan is the Head of Wealth Management Research for Morgan Stanley Australia. Joining in 2016, he reshaped the team’s coverage to support the firm’s holistic advice business. Previously, Nathan worked for Australian Ethical Investment where he...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.