13-12-2021 · 訪談

Talk ’22: ‘It's likely that equity returns will be front-end loaded’

Equities and commodities remain the favored asset classes of multi-asset Portfolio Manager Colin Graham and Strategist Peter van der Welle. However, headwinds next year include Covid 3.0 (which is already with us), the US mid-term elections and China’s economic slowdown. In our 2022 outlook interview series, Robeco’s experts answer key questions about their investing arenas.

Expected Returns 2022-2026 says equities and commodities will be the best-performing asset classes in the next five years. Will that kick in during 2022 or take a bit longer?

“The recent emergence of the Omicron variant has already caused investors to reevaluate next year, leaving strategists scrambling to revise starting points and levels for their predictions. At times like this, we head back to fundamentals to prevent being whipsawed by news flow. For us, economic momentum, interest rates and liquidity are all highly supportive for risky assets, though any US lockdown could cause us to question this outlook. From here, it's more likely that we’re going to get the equity returns this year rather than next year or the year after that – returns will be front-end loaded. The excess liquidity that we have now will decline substantially once the tightening cycle is well underway in 2023 and 2024. And it's very likely that the Bank of England and even the ECB will join the Fed in tightening by 2023 or 2024. The correlation between equity market returns and the balance sheet expansion of central banks has been very high and positive. If balance sheet expansion decelerates, as we envisage over a two to five-year horizon in our main Expected Returns outlook, then indeed it's likely that equity returns will be front-end loaded from that perspective as well.”

“For stocks, earnings expectations are too low for next year given nominal growth, which is supportive for equity and credits. We think earnings expectations will rise over the coming year: margins are currently high, though they will start to fall when input costs and in particular labor costs start to go up later in 2022. So, we do see more upside in equities for at least the next few quarters, and equity risk premiums are still positive relative to bonds.”

Given the resurgence of Covid-19 infections and a new fourth or fifth wave, what will that mean for economic recovery next year?

“There could there be more virulent strains of Covid as we’re now seeing with the Omicron variant as that's what viruses do – they mutate and become more contagious. But at least now we have a roadmap for how governments can deal with the public health threat. We should have seen a 1930s-style depression in financial markets when Covid first hit in 2020, but we didn't because of government action and the fiscal stimulus that kept the economy ticking over. It has all become more manageable and we now have a modus operandi in place. We will perhaps still see some occasional bouts of volatility from Covid 3.0, and some slowdowns here and there, but overall, it will not be the major driver for markets in 2022.”

“We’ve also seen a change of tack in that governments have focused on vaccinations that have reduced the severity of Covid infections and lowered hospitalizations and death rates, rather than trying to eradicate the virus itself. Covid will be with us forever, just like flu viruses. Meanwhile, the reactions by markets to fresh outbreaks have reduced in amplitude, so we shouldn’t see any lasting meltdowns when new variants do emerge.”

Predictions for the likely performance of the major asset classes over the next five years in Expected Returns 2022-2026

Predictions for the likely performance of the major asset classes over the next five years in Expected Returns 2022-2026

Source: Robeco.

Aside from Covid-19, what is the biggest risk or concern we will face in 2022?

“The two biggest risks outside Covid are the US mid-term elections in November and the ongoing tensions with China, though this does not really impact our investment positioning at the moment. For the mid-terms, President Biden will want to keep the voters sweet with economic stimulus and other vote-winning goodies. Inflation isn’t really an issue for voters as the US is generally over-stocked in most goods, and the stockpile of cash on consumers’ balance sheets suggests that more pent-up spending is on the way. People tend to focus more on employment – that’s why the jobs element is prominent in the US infrastructure bill. Biden will try to get the participation rate for the lower socioeconomic classes and blue collar workers up before the election as that will add to the Democratic votes, along with the feeling of success around Biden's measures so far.”

“There remain tensions with China, but Beijing clearly has to focus on domestic issues because the underlying growth picture is weakening, and consumption growth has remained subdued so far. They are still struggling with credit issues and the real estate problem. China’s credit markets are under pressure and the credit impulse is deteriorating, so they’ll look to stimulate growth and prosperity. There is perhaps a risk that the government will look outside its borders for a cause that can unite the people and so deliberately raise tensions in the Taiwan Strait and South China Sea, but it’s doubtful whether this kind of saber rattling will turn into anything more serious.”

What is your inflation prognosis for 2022, given the current worries about rising food and energy prices and potentially a stagflationary environment?

“Inflation is certainly a worry; energy prices are making headlines as the price of oil has hit its highest level since 2014; the price of UK natural gas futures has more than tripled; and even the price of usually unloved coal has more than doubled. But as central banks across G7 continue with highly expansionary monetary policy to deal with Covid, it’s little wonder that price pressures everywhere are growing. This is partly a result of higher-than-average growth coming out of the pandemic: the IMF predicts that the global economy will grow by 5.9% in 2021 and 4.9% in 2022, the fastest two-year pace of growth in more than 50 years. Our central case for Expected Returns is based on moderate inflation and transitory inflationary pressure and reasonable growth; the stagflation scenario is very unlikely.”

“If you look at the shape of the yield curve, bond investors are not particularly worried about inflation. Consensus estimates for the US expect inflation to halve between the first and fourth quarters of 2022, and we largely agree. Given the declining base rate effects of the year-on-year energy price increases, this will cause headline inflation to fall, and overall, the picture will be a kind of battle between receding, non-cyclical core inflation and the price rises that are being created by ongoing supply chain constraints. On the other hand, there is a feeling that a pick-up in wage growth could raise core inflation, especially as the US labor market progresses towards full employment by mid-2022. It will be interesting to watch which force will prevail, but overall it's likely that the inflation numbers will come down from these elevated levels.”

How will the ‘central bank post-pandemic playbook’ play out for multi-asset given the near certainty of Fed rate rises and other monetary or fiscal tightening?

“Hopefully there will be a reassertion of independence of central banks, although this is unlikely given the government debt financing that remains necessary today. We do though expect a more dovish Fed, since Biden has to make three nominations for the FOMC and he can use them to shape policy. He could nominate more dovish members for the committee, or more people with a labor market background that will change the dynamics on the committee. Given the tapering of quantitative easing that is due in the first quarter, we think the Fed will want to see how that plays out before they raise interest rates. They also won't want to do anything from six to eight weeks before the mid-terms in case this is seen as a political move, though theoretically an earlier hike well before the elections could be seen as some hope for Biden because it would address the inflation issue.”

“We think that over the next year, the focus on labor markets will be a bigger driver of central bank action, at least in developed economies. Central banks have the tools to deal with inflation through aggregate demand, but it is much more difficult to contain wage growth as workers get more bargaining power once full employment is reached. Many economies have significant labor shortages, as seen with the lack of lorry drivers in the UK and Europe, which in some cases has doubled the wages of certain groups.”

The influences on likely asset returns over the next five years

The influences on likely asset returns over the next five years

Source: Robeco

If value is making such a comeback as we have seen so far, how would this play into the value versus growth stocks debate for equities?

“Emerging markets are still highly dependent on China and whether the Chinese can turn their economy around. It’s as much a play on China as anything else. Investing in emerging markets also means taking on a lot of commodity-based exposure, and from our top-down perspective, we’d rather approach that as a commodity exposure instead of an emerging market investment. It’s important to remember that there are significant value and growth valuation differentials between emerging and developed markets. It's very rare that leadership changes within a bull market, so as investors we would be more inclined to stick with the winning sectors. The value style is cheaper than growth, but while liquidity is plentiful, valuations have a reduced influence on investor decision making, though taking a look over the horizon there are reduced opportunities for growth outperformance at these more expensive levels.”

“Given the relative duration sensitivity of growth stocks, we would need to see a more notable increase in long real yields (when we envisage only a modest rise in 2022) before changing allocations. In the meantime, there are still tailwinds for growth stocks versus value. Besides the bottoming out of the Chinese credit impulse, we would also like to see a depreciating dollar, which might also take some time. Possibly this would occur in the second half of 2022, given the benign or increasing rate differentials in favor of the US ahead of the Fed tightening. In all, we would be very surprised if emerging market stocks outperform developed market equities or growth stocks in 2022.”

What’s the best (philosophical) advice for multi-asset portfolio managers going into 2022? Follow your instincts, or follow the herd? Any tips?

“The herd can be right and can change its mind often. We need to be open-minded about the macro uncertainty over the path for growth, inflation and labor costs. In this environment we can expect many scenarios to be priced in next year: inflation, stagflation, disinflation, policy errors, stalling growth and Covid 4.0. The key to navigation is to update your core scenario as the facts move, assess where market pricing differs with you, and then invest. This entails taking advantage of the herd’s oscillations, so it works in your favor.”

“If inflationary impulses linger for the next six to twelve months then the bond/equity correlations could switch and therefore the ‘free lunch’ regarding diversification is over. The beauty of diversification is that the correlation between equities and bonds will always bail you out; if stocks fall, then so do bond yields, and the portfolio benefits from that instead. If this no longer holds true once rates start rising, then investing in other asset classes such as commodities or inflation-linked infrastructure will allow us to replace this diversification.”

“We’ll stay true to what we think the economic outcome is going to be, though things do move from one side to the other very quickly; we might face a deflation scare next year. If we start to get things priced in that we don't believe in, then that's where we would be looking to be more contrarian. One should keep an open mind about which inflation scenario unfolds, while overall macroeconomic uncertainty is still elevated from an historical perspective. That means that you could see big swings in markets that we can benefit from in 2022.”


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