2022 looks familiar, though not quite the same

This might come as a surprise, but reading through investment strategy reports for 2022 and listening to fund managers, there is far more agreement than disagreement about what is likely to occur in 2022. Global growth is slowing and will continue to decelerate. Inflation will peak soon and then start descending. Central bank policies become less accommodative. And bond yields are trending higher. Where disagreement kicks in is in the speed and timing of these events. I've drawn on the forecasts of Westpac's highly regarded economist Bill Evans around the timing of crucial policy shifts and share my views on the implications for portfolios. 

This might come as a surprise to many readers, but, reading through investment strategy reports for 2022 and listening to funds managers on webinars, there is far more agreement than disagreement among the world's experts about what is likely to occur in 2022.

Global growth is slowing, and will continue to decelerate. Inflation will peak soon, and then start descending. Central bank policies become less accommodative. Bond yields are trending higher. And the world will have to start living with the virus and its multiple variants, with bumps and set-backs along the way.

Where disagreement kicks in is in the speed and timing of these events.

Questions like: "when exactly will the yield on the US 10-year government bond reach 2% and at what speed?" can momentarily become very important for a market that at times feels like it wants to have that big correction so many investors are fearful of.

Equally important: so many portfolios are positioned for re-opening borders and re-flation, but those trades have become crowded and volatile as also witnessed by share prices in Webjet ((WEB)) and Flight Centre ((FLT)) and the like; even before omicron announced itself.

At the index level, the Australian share market has effectively been in a moribund state since the second half of the August reporting season. And our two largest sector constituents -banks and iron ore producers- have been directly responsible for it. Investors can thank China and a disappointing banks reporting season.

At the smaller end of the market, things have soured quickly for stocks that enjoyed widespread popularity not that long ago. The likes of PointsBet Holdings (PGH), Codan (CDA)), Bapcor ((BAP), Damstra Holdings (DTC), Nearmap (NEA) and Appen (APX) have all been testing how much pain can be inflicted on shareholders without them capitulating and selling out (though many would have, by now).

Year-to-date the Australian market (ASX200 plus dividends) is still up more than 14%, which would be seen as a positive outcome in most calendar years, in particular given the many question marks and potential challenges that are on investors' minds.


The two most important factors for the year ahead might well be growth and inflation, with corporate profits and asset valuations squeezed in between.

2021 has brought back inflation but many remain of the view the narrative is overcooked and bond markets may have overdone it in the short term.

At the source of this year's spike in global inflation are the low comparatives a year ago, plus ongoing disruption from closed borders, lockdowns and other virus-related impacts, and, in the US, the mystery disappearance of more than 4m workers that may or may not return into the labour market.

While the debate rages on, and there are valid arguments and forecasts either way for each of the separate constituents, fact remains the chances of international shortages and bottlenecks remaining in place for (much) longer are genuine and real, and this increases the chance that inflation might become a self-reinforcing process, in particular if those 4m non-job seekers in the US remain missing.

Hence, last week economists Bill Evans and Elliott Clarke at Westpac revised their timeline for the Federal Reserve in the US next year with the central bank expected to announce accelerated tapering at its upcoming December 14-15 meeting with rate hikes to follow in June, September and December next year (25bp each).

What follows next is equally important as Westpac too is of the view that inflation will decelerate throughout 2022, and GDP growth is to remain healthy so Jerome Powell & Co can remain accommodative which, on Westpac's forecast, should result in a fairly benign pace of rate hikes in 2023-25.

Westpac only anticipates three more hikes (3x) -one every six months- between June 2023 and June 2024 which takes the federal funds rate to 1.625%.

The above scenario has major implications for the trajectory of currencies. The USD is expected to strengthen over the next six months, pushing the AUD potentially below 70c, but start weakening from the moment other regions like Europe are strong enough to embark on their own rate hike cycle.

Most importantly: the pulling forward of the timing of US rate hikes is not expected to have any impact on the RBA timeline. Westpac is still of the view Philip Lowe & Co won't lift a finger before February 2023.

It goes without saying, Westpac is but one forecaster in a world of many, but in particular Bill Evans has built up a commendable track record over his long career. It's why his name is held in high esteem among colleagues, journalists and investors in Australia.


Let us for the time being assume Evans and Clarke are closer to next year's actual outcome than the many dissenting, hyper-ventilating voices on TV and social media. This has a number of major implications for asset markets:

-bond yields today are too low, but yields won't need to double again as they did earlier between mid-2020 and early 2021

-global inflation will eventually trend back to where central bankers like it to be, assisted with a relatively small number of rate hikes (certainly within historical context)

-economic growth too will trend lower, but this need not mean another recession is inevitable or on the immediate horizon

-the RBA need not follow the FOMC in haste, contrary to what the local bond market is suggesting

Underlying, the key message for investors seems to be that market volatility will remain high, in particular if US 10-year bond yields make their way from currently below 1.50% to, say, 2.50%.

However, in the absence of much stronger and more persistent inflation, or much weaker economic growth, next year should not mark the end of the bull market for equities.

In fact, if we take the above cocktail and add historically elevated valuations there is a fair argument to be made that 2022 shares a whole lot of common characteristics with the year past.

Without further much ado, I thus predict multiple attempts for portfolio rotation into Value and Cyclicals and out of Growth, Quality and Defensives.

Some of these attempts will be more successful than others, but on a likely middle-of-the-road scenario outcome, investors better not forget that mega-trends carry their label for very good reason, and covid and technology are changing the world and reshaping the future.

Higher bond yields might lead to a sell-off in higher valued, strongly growing companies-of-the-future, as long as that growth remains in place, their share prices will stage a come-back, and move beyond, ever onwards and upwards.

Because investing in the share market is ultimately investing in growth. Nothing more and nothing less. As long as you don't pay a crazy price to get on board.

Within the context that creates itself from the ingredients above, the importance of patience and "timing" might become more prominent in 2022.


One key difference that needs to be highlighted is the outlook for corporate profits locally which looks a lot less broad-based and less promising than it was earlier in 2021 and last year.

This difference is easily illustrated through the numbers. FY21 saw Australian companies on average improve earnings per share by more than 25%.

For FY22 that number is circa 13%, but... most of that growth seems already behind us. On assessment by market analysts at Morgan Stanley the twelve months forward looking EPS growth number has recently sunk to 4.7%.

Market consensus for FY23 and FY24 sits at rather weak 3% and 2.6% growth projections.

In Australia, contrary to the USA, market consensus aggregate EPS expectations peaked in August, and have been in noticeable decline since.

Apart from the banks, insurers and iron ore producers, forecasts are falling for Webjet, Crown Resorts (CWN), Lovisa Holdings (LOV), Appen, United Malt Group (UMG), Nufam (NUF), Virtus Health (VRT), and numerous others.

This, I think, is the real message to take home for the year ahead: overall dynamics are getting tougher for corporate Australia. In order to avoid being hit by the next profit warning or otherwise corporate disappointment, it looks wise to dial back on the overall risk-taking.

It's very striking, also, that in the US experts are debating how much leaner and more profitable American companies are becoming as they adopt new technologies and adapt to the changing times, while in Australia, at the top end in particular, the corporate dynamics look a lot less promising.

Also, if we take a leaf from the 2021 playbook, things are bound to get hairy at times, sometimes scarily so. As we've all observed over the year past, indices do not necessarily reflect what is really going on across the market, and portfolio rotation can inflict significant damage on individual stocks, even if it lasts only temporarily.

The lesson I learned from experiences from the years past is it is best to use volatile times to cleanse the portfolio and get rid of disappointers and never-deliverers. Many an investor secures profits and gets stuck with the losers. I believe best practice consists of doing exactly the opposite.

And, of course, it's always great to have cash on the sidelines. Have as much as you need to sleep well.

FNArena offers impartial and independent commentary and analysis for investors who conduct their own research, on top of proprietary tools and data. The service can be trialed for free at (VIEW LINK)

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