There has been a sharp shift in market and client sentiment since the end of 2021, driven largely by questions about the economic outlook and the potential for higher interest rates to damage returns.
But away from the immediate-term volatility, what is the longer-term outlook?
As 2021 came to a close and 2022 began, three headlines from the Financial Times neatly summarise the past 12 months and pose the key question regarding the next 12:
- “Global stocks deliver third year of double-digit gains”;
- “Global bond markets on course for worst year since 1999”; and
- “The key to 2022 will be how inflation is brought down”.
It has indeed been another year where investors were rewarded for being exposed to risky assets. Global equities had another banner year, underpinned by strong macroeconomic tailwinds and enormously stimulative monetary and fiscal policies. Investors with strong stomachs have participated meaningfully in this latest leg of a bull run that has been in motion – with some notable exceptions – since 2009.
Equities, once again, were led by an irrepressible US market that surged by 27 per cent throughout 2021. Notably however, the US equity complex has not been characterised by frenzied investors speculating with reckless abandon: 2021 earnings will almost certainly have risen by a greater degree than 2021 prices in the final tally.
Moreover, this has not been a year where large mega-cap technology companies left others in their dust: the equal weighted S&P 500 ended the year ahead of the standard, market capitalisation S&P 500 index for the first time since 2016.
Nonetheless, while US equity valuations have not risen over the year, they remain expensive by historical standards and investors are struggling to identify more attractively valued opportunities elsewhere, specifically in other regions such as Europe, the UK and Japan.
While no market has performed as well as the US in 2021 – indeed, emerging markets, led by China, were a painful under-performer given Chinese regulatory crackdowns on technology companies and real estate woes – non-US equities’ long-term prospects remain attractive given better valuations and a higher sensitivity to economic cyclicality. With regard to emerging markets specifically, the region is looking oversold from a sentiment perspective, often a precursor of outsized future returns.
While risk assets have basked in the sun, safe-haven assets – ironically – have experienced an annus horribilis. Ten-year UK government bond yields shot up from about 0.20 per cent to as high as 1.60 per cent, an eight-fold increase. That equated to a capital loss of about 9 per cent (Bloomberg UK Gilt 7-10Y Index; index total return level).
Investment-grade corporate bonds also lost money, but less than government bonds. In line with the trends of the year, the best-performing credit was the riskiest variety, with high-yield corporate bonds delivering positive returns.
Most investors’ multi-asset portfolios still require a need for defensive positioning despite poor performance or growth prospects; at least compared to risk assets. Given a panoply of risks – elevated equity valuations, Covid variants, stubbornly high inflation, the potential for central bank policy errors, geopolitical risks such as the ongoing Russian invasion of Ukraine, and Chinese real estate contagion – risk-taking should be tempered and, should risk assets sell-off and safe-havens rally, one should exit the latter in favour of finding bargains in the former.