9 key takeaways from Wilsons 2022 outlook

The spectre of sustained high inflation and the behaviour of bond markets continue to perplex market observers as the year draws to a close and attention turns to 2022.

These themes figure largely in the December episode of the Wilsons Invest It Best podcast, featuring Wilsons leaders David Cassidy, head of investment strategy, and John Lockton, head of Australian equities.

Recorded in early December, the conversation looks back to imagine the way forward, drawing on lessons from a year ... well from a year like no other.

This wire captures the nine key takeaways from a wide-ranging discussion that slips between the macro and the micro; the global and the domestic.

#1 The word 'transitory' has been officially retired

By the close of 2020, markets had recovered from the early panic of the pandemic and were feeling brave enough to look forward to the new year.

“I think the expectation was that it would be a reasonable year for stocks, and I think we largely got that,” Cassidy says. “So from that perspective, it was perhaps an unusual year in that we got what we were looking for.”

The big surprise was inflation. “I think there was an expectation that with all the stimulus in the system, we would see inflation at some point in this cycle, but I think the surprise is just how quickly it came through and how strongly.”

But would it be merely transitory? And just how transitory is transitory?

“I think the transitory structural debate started when we actually saw surprising inflation,” Cassidy says.

“Probably about six or seven months ago, around about April-May, we started to see some big numbers come out of the US.

“And now we've come to the position where the chairman of the Federal Reserve, Jerome Powell, has actually officially retired the word ‘transitory’.

“I didn't know he could do that, but he's done that in his little speech last week.”

Cassidy predicts consumer spending will begin to shift towards services rather than goods, and supply chains will catch up with demand.

“I think you will see inflation come off the boil, but it might take a few more months and there's always the risk that markets panic about inflation not coming off somewhere over the next few months.”

#2 It’s been a stinker of a year for bonds

Another feature of 2021 has been the lack of volatility in the bond market.

“Bond yields just don't really want to go up,” Cassidy says. “And certainly, if they go up, they don't want to stay up.

“If you measure it by certainly current inflation, which is very high, or even long-term inflation expectations, you've still got deeply negative real yields, certainly everywhere, but in the US in particular.

“I think it’s interesting and perhaps perplexing that US 10 years are still only at 1.5% with a 6% headline inflation rate. Even if you look at the core measure, it's still above 4%. I would've thought bonds would've pushed up more than they have.”

#3 Macquarie does it again. Again

The environment of 2021 was difficult for global investment houses, but Macquarie Group’s performance confounded those who think its fortunes are tied to capital markets. Lockton is not surprised.

“I think what we're starting to see in this business is that it's not just reliant on bond market or equity market volatility; it's not just reliant on ECM (equity capital markets)," he says.

“The structural pivot which Macquarie has made over the last few years, whether it's pushing into the clean and green energy space, whether it's technology, whether it's serious investment in asset management and also in traditional forms of energy — a lot of those areas are being powered by structural growth drivers.”

#4 Higher interest rates = lower Tech sector

The threat of rapidly rising interest rates has weighed heavily on the technology sector, punishing the likes of Cathie Wood’s Ark Innovation ETF, which fell 15.1% in the year to the end of November. The Ark Genomic Revolution ETF shed 32.05% in the same period.

“It's still uncertain whether it's a 2021 story or a 2022 story,” Lockton says. “I think the number one driver of what's been happening, not only in Cathie's fund, but also across Aussie tech in the last six weeks or so, is just exactly how fast and in what timeframe does the Federal Reserve start to lift interest rates.

“There's a lot of technology companies, both here in Australia and in the US, which don't make profits today but are expected to.

“And a bunch of those stocks have fallen 30, 40 or more per cent from all-time highs. In many cases, some of those stocks have given up all the bull market gains of the last two years.”

#5 Omicron doesn’t look too scary (for now)

When Cassidy and Lockton recorded in early December, interstate travel was still largely locked down, but even then the Omicron strain of COVID was appearing more benign than Delta has been.

“We still haven't seen any really bad news in terms of the health impacts of Omicron versus, say, Delta,” Cassidy says.

The bulls want to believe Omicron will ultimately prove more benign and will become the dominant strain, allowing the dangers of COVID to recede into distant memory.

“I don't think the pandemic's going quietly, but I think the market is more relaxed than it was on the pandemic,” Cassidy says.

#6 Bulls just want to have fun

Bulls have their place, but some of them just don’t do pessimism. And anyone acquainted with the history of public health knows pessimism is sometimes the best response. That’s when the bears hold the floor.

Lockton says it’s conceivable that corporate earnings will accelerate in 2022 and into 2023, building a solid base of optimism.

“I kind of want to be greedy here — you want to make sure we get those earnings numbers in 2022, but also have upgrades in our pocket for 2023,” he says.

“That could occur with obviously the borders between all the states and ultimately international borders opening. That would help on labour mobility; it would also help just generally with sentiment.”

A rise in the Australian dollar would reinforce that buoyancy and give resources stocks a boost.

On the flipside, Lockton thinks any hiccup in forecast earnings growth would be a challenge to the domestic equities market.

“We do have a federal election next year and I think the market is really expecting that to be a bit of a non-event,” he says.

“If that was a long, drawn-out federal campaign, perhaps with a change of government on a large policy pivot, which is not in the market's mindset at the moment, that could well be a hand break for the equity market, particularly in the first half of next year.”

#7 Bears, on the other hand, dwell on higher inflation

Unless the pandemic slaps down another wildcard, the bear case for 2022 relies on high inflation setting in and triggering central bank intervention to dampen growth.

“If we do get persistently high inflation, if it doesn't prove to be transitory, that is the big issue out there for markets,” Cassidy says. “I think that's what could really upset the apple cart over the next 12 months.”

He expects problems for risk assets and possibly bonds if inflation doesn’t simmer down by the second quarter.

“It's hard to know how bonds will react to that, because they might just price in a very aggressive Federal Reserve killing growth and might actually rally, but it's certainly a problem for risk assets.”

#8 Cheer up. 2022 is looking good

The Wilsons team have positive expectations for global and domestic equities in the new year.

“Our central case is still an above-trend year for economic growth and therefore earnings growth,” Cassidy says.

“Inflation may be stubborn near-term, but should subside as the year progresses. That will mean that the inflation environment will allow interest rates to stay pretty low.

“They might come up a little bit over the course of the next 12 months, but not enough to really short circuit the equity rally.

“We’re still overweight equities, underweight bonds and we still like alternative assets to provide a little bit of diversification around that base-case view.”

#9. It's a bird. It's a plane ... it's the Flying Kangaroo bouncing back

As much as the pandemic punished businesses exposed to travel, its retreat should quickly reward them.

In the case of Qantas, Lockton says domestic rather than international demand is the key to profitability.

As state borders gradually reopen, the Flying Kangaroo will regain its balance.

“You think about the three states on the east coast — Queensland, New South Wales, Victoria — and they’re the Golden Triangle in flying terms,” Lockton says.

“The domestic side is critical for Qantas, and I think it's two things which are needed there.

“It's one, the legitimate opening of borders and that includes WA eventually, but it's also, from a customer perspective, the confidence to be able to fly even domestically and not have too much hassle with various forms of COVID testing and variable policy.

“We know there's plenty of pent-up demand; we know consumers have money to spend and the appetite to go on a domestic holiday.

“We could see the domestic business of Qantas return quite rapidly to a pre-COVID level towards the end of next year and very early 2024.

“And that would effectively take your earnings back to 85% to 90% of where Qantas was pre-COVID.

“We all love an international holiday, but it's really the domestic side of Qantas which is most critical for getting the share price up from where it is at the moment.”

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