US inflation hits 7%, the highest for 40 years and the Fed talks tough. We did say January would be choppy and it certainly is. The NASDAQ is the weakest of the major markets so far this year, the FTSE 100 and Hang Seng have been the strongest. How times change.
Despite the wobbles and the threat of higher interest rates, we still think that risk assets will generate positive returns this year. Here’s why: the global economy is growing, and corporate earnings will follow suit. In the developed world, consumers are sitting on a pile of cash, unspent proceeds of fiscal stimulus during lockdown. Yes prices are rising but so are wages and employment. In the US, employment is up 4% on a year ago, wages are up 5% with the strongest growth amongst the low paid, who spend every penny they earn. And its’s not just consumers who are enjoying healthy finances. Companies have strong balance sheets, healthy profit margins and rising revenues. So it’s not surprising that there’s a global capex boom underway.
Downbeat analysts’ estimates will mean another bumper earnings season
We are in the early days of the latest reporting season and we expect companies to strongly beat analysts’ estimates. That won’t be difficult because analysts have started the year with unusually low numbers. More important will be the outlooks for the rest of the year that the management teams give. We reckon that they’ll be bullish.
Withdrawal of financial support a headwind, and small cap may struggle
Now, pessimists may say that the central banks are set to raise rates, bond yields have already gone up and that equities will fall as the financial support is withdrawn. Yes, higher rates are a headwind but as long as the economy continues to expand, risk assets should do well. Yes, there will be market setbacks, but past experience shows equities usually perform well in the run up to, and for 6 months after, the first Fed rate hike.
What we could see is a continued rotation out of the expensive tech stocks into cheaper value stocks. We’d qualify that by noting that companies that lack pricing power might struggle to pass on those rising wages onto higher prices. Some small cap companies might therefore struggle too.
Political strife and cost of living squeeze will impact the UK
Back in the UK, there is an almost daily diet of partying in and around No 10 Downing Street during lockdown. Many believe that Boris Johnson’s days as PM are numbered. We’ll see. But we don’t think it’s a major issue for financial markets. The cost of living squeeze is a huge issue here and the government will act to ease the pain. It will also be very interesting to see if the Chancellor cancels the planned increase in National Insurance Contributions due in April. If he does, that would be a strong signal that he’s hoping to move into No 10.
Whatever happens, the UK faces higher inflation and rising rates. But the economy will continue to grow as our consumers too still have plenty of unspent cash.
Positive returns for developed equities in 2022, but it won’t be a smooth ride
Rising interest rates, high inflation and less bond buying by central banks add up to a negative background for government bonds. That’s also a headwind for equities so I can’t see really strong performance in 2022, but high single digit total returns look eminently achievable to me. Earnings should grow faster so this performance can occur even as bond yields rise. One thing is for sure – it won’t happen smoothly.
Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.