Equity markets will be tough in 2022 but not hostile

George Dent, client investment manager at the Edinburgh-based investment house, which sits under the BNY Mellon Investment Management Umbrella, acknowledged consensus was pointing to 2022 being a tougher year for equity investors.

However, he said this should not obscure that the asset class still has much in its favour.

Dent commented: “Cost pressures, once confidently – and not unreasonably – dismissed as transient, have proved frustratingly stubborn in recent months, and while it is likely that some of the contributing factors to this will moderate in the near term, above-target inflation looks set to persist. 

“The result will be tighter monetary policy, as central banks move to reign in stimulus programmes, and some seek to tentatively raise interest rates.”

For many investors, a world of inflationary pressures and still-low bond yields means there is no alternative to equities.Dent

He said that a coming together of higher borrowing costs, prices and wages poses a challenge to corporate earnings and margins, at a time when global equity indices are trading around record highs after another year of stellar returns. 

“Earnings are going to have to work hard to continue to justify current valuations, and a period of realignment between fundamentals and valuations may be inevitable. 

“None of this is even to mention the fact that it is still much too early to dismiss the possibility of further pandemic-related complications for the economy. The impact of the Delta variant on activity in the US and elsewhere was proof of the damage the virus can still cause", he explained.

But according to Dent, this is not to say the sector is "un-investable" and he said the asset class still had much in its favour. 

He said: “Economic growth is broadly healthy, labour markets are healing, and consumers have money and, more importantly, are spending it. 

“The ever-reliable US consumer especially is sitting on significant levels of excess savings. 

“History tells us that we can expect much of this to find its way into corporate cash registers.”

Furthermore, he said, while monetary policy may be gradually turning more hawkish, fiscal policy is still tilted firmly towards stimulus, with the US showing signs of bolstering long-term economic growth. 

“President Biden’s $1tn (£760bn) infrastructure programme and the European Union’s €800bn (£683bn) ‘Next Generation’ fund should both bolster near-term economic growth. If this capital is allocated sensibly then the boost may even have real longevity.”

Nor should investors underestimate the resilience and adaptability of the corporate sector, he said.

Rising raw material prices and wages are problematic, but so far companies have handled them well. 

“Cost management initiatives, productivity enhancements, and pricing power have combined to push corporate margins to record highs, defying expectations of a profit squeeze. 

“Sustaining these levels may be unrealistic in the face of a prolonged period of higher input costs, but the evidence of 2021 suggests that any margin compression may not be as severe as some fear.”

Finally, Dent said, there is always TINA [there is no alternative]: people will invest in shares because there is no other viable option for their portfolios.

He commented: “For many investors, a world of inflationary pressures and still-low bond yields means there is no alternative to equities. 

“Appetite for the asset class, whether from private or institutional investors, remains correspondingly robust, and the resumption of share buyback programmes by cash-rich companies should only serve to further spur demand.”

So, while there are undoubted challenges ahead, he said, the environment for equity investors was "by no means hostile". 

“Although a repeat of the returns of 2021 is likely wishful thinking, there remain abundant opportunities for financially strong, well-managed, resilient companies to prosper.”

sally.hickey@ft.com