As we enter 2022, we continue to prefer equities to other asset classes, such as eurozone government bonds and cash. This preference is predicated on the enduring relative valuation thesis, robust corporate earnings expectations, and the positive global growth trajectory.
Whilst the latest bout of COVID induced volatility should subside in time, markets are finely poised with shifting inflation expectations and the potential for a policy misstep contributing to a possible bumpy road ahead. Although less severe this winter, the full extent of the impact of lockdowns across Europe will not become clearer until late January when the first economic datapoints covering the new year are released.
Sentiment in equity markets is more cautious, and ultimately less exuberant than it has been throughout the early parts of 2021. However, this makes the current equity bull market more sustainable and the higher cash levels seen across the market as a whole can be deployed as opportunities arise.
Consumers and companies alike are both generally well positioned, with positive earnings growth, enduring excess savings, and cheap credit conditions all supporting a preference for equity markets. Both the fiscal and monetary policy backdrop are shifting, but remain loose, or accommodative, versus history.
Recent market volatility typically accompanies the initiation of a central bank tightening cycle, but crucially this has not proven to be an obstacle for continued positive returns in the past. Our more cautious outlook on eurozone sovereign debt remains intact.
As key central banks move towards a more hawkish policy stance, bond buying programmes will be scaled back and expectations of higher interest rates will put downward pressure on bond prices, particularly longer duration issuances.
The supply-demand dynamics of key markets could also shift as increased government fiscal measures are met by reduced central bank purchase programmes. Sharply higher bond yields is not our base case, but our asset allocation stance affirms the view that eurozone sovereign debt, which currently yields close to, or below, zero could also see further capital losses in 2022. This would lead to a negative total return for investors.
The key risks evident currently in the global economy centre around shifting inflation expectations and the potential for subsequent policy error. The Federal Reserve has already dropped the concept of ‘transitory inflation’, the Bank of England has already moved rates higher, whilst the ECB maintains that a rate rise next year is ‘unlikely’.
Central Bank divergence as policymakers react to datapoints within their own jurisdictions could emerge to be a key narrative during the year ahead. Additionally, the market currently expects a fiscal infrastructure spending package from the Biden administration. The mid-term elections in 2022 could see a shift in the balance of power in Congress and has historically seen higher levels of volatility.
Geopolitical risks could also return to the fore, as key flashpoints in Ukraine and Taiwan respectively could pit the US against old and new foes.
Finally, as vaccine efficacy, variant mutations, and the evolving policy response all oscillate, the pandemic will continue to be the centre of market attention at junctures throughout 2022.
Overall, our current positioning is a preference for equities. Some profits were taken throughout November which provides flexibility to deploy resources back into equities if opportunities emerge. We remain towards the lower end of ranges within sovereign bonds and maintain a positive, albeit selective perspective, towards corporate bonds.
We remain positioned for positive equity markets as market trends can persist, and they do not have to revert in the medium term. However, this does not mean we would be surprised by further turbulence. Volatility will emerge from key events throughout the year, and as ever, a flexible approach within a proven framework will be the best course for a potential bumpy road ahead.