Outlook 2022: Global economy - from pandemic to endemic

Key points

• The next twelve months will likely see COVID-19 move from a pandemic to endemic phase. While more outbursts of infections are likely, they should not hurt growth much.
• Leading central banks are likely to reduce crisis stimuli measures more next year, including raising rates. The persistence of more elevated levels of inflation may dictate how quickly this can be achieved.
• A world in which the pandemic is history, is one that favours 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.
• That said, equity returns are likely to be average at best in 2022. 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.

The outlook for global financial markets is better than it was twelve months ago. The world is getting used to living with COVID-19 and several developed economies are close to their pre-pandemic levels of output. That said, our message to investors in our Outlook 2022 is the same as twelve months ago; one centred around the importance of favouring a balanced and diversified approach to help navigate a very uncertain backdrop. Yet, the sources of uncertainty have changed.

Back to the future

By and large, life today isn’t very different from the one of 2019, largely thanks to vaccines allowing economies to reopen and activity to resume relatively quickly. That said, the turning off of demand and supply in 2020, followed by a surge in demand this year, has caused frictions in supply chains and for employment in some jobs.

As a result, inflation fears, allied with the speed with which central banks raise interest rates, are on investors’ minds. This is likely to continue next year, at least initially.

From pandemic to endemic

Indeed, starting in 2022, and assuming that vaccine-resistant variants don’t spoil the party, we believe that COVID-19’s status will transition from pandemic to endemic, making it akin to the seasonal flu. Outbursts of infections are highly likely, though these should only be a marginal drag on global growth. Implications for investors include the effects on central bank policy, inflation, the “TINA”, or there is no alternative, mind-set and expectations of lower returns, as we detail below.

After doing “whatever it takes” to support their economies, central banks are planning to accompany the transition to the new normal by easing their crisis support. The pace of this change in policy emphasis will vary by region. In turn, this may lead to increased volatility in rates and currency markets. It will also likely promote more frequent sector rotations, and dispersion, in equities.

Unfortunately, this scenario is valid only if inflationary pressures don’t force central banks’ hands. And, the recent surge in energy prices, that might be more persistent than many first thought, has changed the market’s perception on inflation. That said, any fears of inflation being over 3% for a long period appear overblown. While concerns may continue to grow 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 shine

The prospect of a world transitioning to a post-pandemic mind-set still favours 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. Additionally, continued earnings growth should support equities. The prospect of prices staying elevated for many months also points to investing in equities, that tend to be a better hedge against inflation risk than most bonds.

We expect 2022 to be an average year at best, with demanding valuations across most asset classes limiting the potential for gains. As such, investors may need to widen their investing horizon, whether with more of a sector or individual security slant, rather than by market, or by gaining exposure to private markets and alpha-based, market-neutral strategies.

Taking the long view

With so much uncertainty in the near term, it may be time to focus more on long-term objectives. Indeed, over the next five years, we expect the transition to a post-pandemic world to bring growth closer to historical trends, and interest rates gradually higher. That said, this ignores any potential unforeseen shock occurring.

Being and staying invested continues to make sense, as does preparing for more elevated volatility, and potentially slightly lower-than-average returns.

In taking a long-term view, a focus on environmental, social and governance (ESG) considerations matters. ESG factors will probably play a key role in directing additional government, and private, spending patterns, while adding to volatility in commodities as the energy transition gathers pace.

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