After a couple of years in which investors have navigated a global pandemic, the deepest recession since WWII, an impressive economic recovery and a strong rebound in equity markets, one could be forgiven for hoping for a more predictable investment environment in the year ahead. But with the Federal Reserve poised to deliver rate hikes next year and markets generally trading on the more expensive side of longer-run valuations, we suspect the coming year will deliver both opportunities and challenges.

Looking ahead, we still see value in positioning for out-performance of growth assets vs. defensive assets. The good news is that 2022 should bring a partial reversal of the stagflation narrative that has plagued markets of late. In our view, inflation will moderate in 2022 and growth should accelerate relative to recent outcomes. This should be a more favourable backdrop for markets, albeit one which we acknowledge does have a touch of Goldilocks about it.

Policy settings are likely to be less supportive of economic growth in the year ahead

However, a significant shift in the policy backdrop as both monetary and fiscal policy turn less supportive for growth will mean that investors will likely need to accept more moderate out-performance of growth assets relative to defensive assets, compared to recent experience. Moreover, higher real short rates and slower growth in central bank balance sheets will likely be an unfriendly combination for those stocks, sectors, or markets that are very expensive.

And just as the last couple of years haven’t disappointed in terms of delivering unexpected turns, 2022 will no doubt contain its share of surprises. COVID-19 is in the process of transitioning from pandemic to endemic, but recent events illustrate its capacity to continue to surprise. China appears to be in the midst of a significant policy re-design, and the Fed may yet shock with a more aggressive and rapid tightening cycle. Policy risks remain as a source of potential surprise in the year ahead. Lastly, geo-political risks are always present, but in 2022 they lurk in the form of US mid-term elections, energy market politics and in a domestic context, the US/China and China/Australia relationships and the upcoming Federal Election.

At an asset class level, our key views are:

• Australian Equities: we remain positive on the outlook for Australian equity market returns in the year ahead, but we think more moderate earnings growth and already somewhat elevated valuations will likely deliver more subdued returns in 2022 relative to 2021. Discretionary services consumption, infrastructure, LNG and commodities leveraged to the production of clean energy are likely to perform well, in our view. We also note that the earnings yield of the ASX200 is still elevated relative to the 10-year government bond yield; all else equal this should support the market.
• International Equities: we observe that the global economy should deliver above trend growth next year. However, lingering uncertainties around inflation, the pandemic and the path of bond yields argue for diversification across sectors and styles.
• Fixed Income: we retain a preference for credit exposure over government bond exposure on the view that credit quality remains strong. Positive fundamentals and technicals should support credit spreads in 2022, in our view. We expect yield curves to flatten further in the year ahead, implying that longer end nominal yields should remain well contained.
• Real Assets: the key themes we are watching for the sector (and across alternative investments more broadly) are the post-pandemic economic recovery, the search for alternative sources of return, and the transition to a sustainable economy. We expect this asset class to be well supported as investors continue to seek exposure to growth assets that add diversification to portfolios.
• Uncorrelated Assets: we observe that as the correlation between equities and credit remains at elevated levels, the case for uncorrelated strategies in 2022 strengthens through greater diversification, alpha-centric strategies, and expansion of new investments such as carbon and digital assets.

For markets, we expect curve spreads to continue to flatten and for the out-performance of growth assets vs. defensive assets to moderate

In summary, we remain constructive on the macro-economic backdrop in the year ahead. Growth should pick up as we move into the new year, and inflation dynamics should moderate somewhat through 2022. This backdrop suggests that there is still some risk premium to be earnt by running multi-asset portfolios that are biased towards growth assets. However, we think it important to acknowledge two key aspects of the 2022 outlook. First, the stellar gains in most growth assets in the past 12-18 months are unlikely to be repeated next year. While growth assets should continue to out-perform defensive assets, the extent of this out-performance is likely to moderate relative to recent outcomes. Secondly, the policy backdrop will turn less supportive for growth in the year ahead, which may be portend a more difficult environment for those stocks, sectors are markets that enter the new year with already expensive valuations.

Please contact your banker or adviser for a copy of the full JBWere – The Outlook For Markets In 2022 report

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The information contained in this email is gathered from multiple sources believed to be reliable as of January 2022 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, JBWere recommends that you consider whether it is appropriate for your circumstances. JBWere recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2022 JBWere Limited ABN 68 137 978 360 AFSL 341162.