Outlook 2022: Post-pandemic investing strategy

Key points

• COVID-19 is likely to move from a pandemic to endemic phase in 2022. While more viral infection outbursts are likely, they should not hurt growth much.
• As coronavirus transitions to the endemic phase, such a world suggests equities can outperform bonds. However, next year is likely to be average at best for investors with rich valuations limiting potential gains. Despite such valuations, the equity risk premium remains in line with its historical average.
• Inflation may stay elevated for some time yet and affect the pace at which leading central banks can reduce crisis stimuli measures next year.
  
• Volatility looks set to remain high next year, with uncertainty to the fore. As such, it may be worth considering investing in sectors or individual securities, rather than broad markets, or by gaining exposure to private markets and alpha-based, market-neutral strategies in chasing higher returns.
  
• As the world strives to eliminate carbon emissions, environmental, social and governance factors are likely to play a bigger role in financial markets. The increased flows being diverted to ESG may add to volatility in commodities as the energy transition gathers pace.
  

With the economy bouncing back and US equities hitting fresh highs, the outlook for global financial markets is better than it was last November. While supply bottlenecks are one consequence of the world adjusting to economic life with COVID-19, bottlenecks are expected to ease next year. Despite such problems, output in several developed economies is close to pre-pandemic levels.

Despite the stronger economies and financial markets seen this year. The key message to investors in our Outlook 2022 is the same as twelve months ago; the attractions of favouring a balanced and diversified approach to help navigate a very uncertain backdrop.

Finding a new normal

Life today, by and large, doesn’t feel much different from what it did before coronavirus hit in early 2020. Vaccines have allowed economies to reopen and activity to resume relatively quickly. That said, some industries have been affected more than others by the switching back on of demand and supply this year. The resulting surge in demand continues to outpace supply, leading to frictions in supply chains and labour shortages in some jobs.

Consequently, inflation fears, along with how quickly interest rates are raised by central banks, are affecting investor sentiment.

From pandemic to endemic

We expect to see COVID-19’s status switch from pandemic to endemic next year, making it like the flu. While outbursts of coronavirus will continue to occur, these are likely to have only a marginal drag on growth. In turn, transitioning to an endemic will probably affect central bank thinking, inflation, the mentality of investors and expectations of lower returns, as we now outline.

Central banks’ careful U-turn

The first impact will be felt on monetary policies. After doing “whatever it takes” to support their economies, central banks are expected to remove some of their emergency stimuli introduced to fight the crisis. The normalisation process will probably be relatively slow. The pace of the policy tightening will vary by region. This is likely to lift volatility in rates and currencies markets. More frequent sector rotations seem probable as a result of the varying pace of tightening, and a wider dispersion in equity returns within markets.

Of course, stronger-than-expected inflationary pressures may force central banks’ hands. The recent surge in energy prices, that might last for longer than many initially thought, increases inflation risk. But this needs to be put into perspective. Suggestions of inflation being over 3% for many months seem wide of the mark. While elevated inflation may continue to be a hot topic for investors in the first half of 2022, we expect inflation to be less of an issue in six months’ time, preventing a sharp tightening of monetary policies.

Equities to remain in vogue

The idea of a move to a post-pandemic mindset continues to point to equities over bonds, in our view. Despite US equities hitting fresh highs in November, the equity risk premium remains in line with its historical average. Continued earnings growth should support equities too. The risk of inflation remaining relatively high for many months suggests investing in equities rather than fixed income, equities tending to be a better inflation hedge than most bonds.

Next year is likely to be an average one at best, with rich valuations in most asset classes limiting the potential for gains. As such, investors may need to invest further afield than usual, whether with more of a sector or individual security approach, rather than by market, or by investing in private markets and alpha-based, market-neutral strategies.

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