By Invesco’s Global Head of Asset Allocation Paul Jackson
It is time to forget central scenarios and think about improbable but possible outcomes. Market sentiment is now mixed (thanks to the Fed), so our list of surprises contains something for everybody (these hypothetical predictions are our views of what could happen even if they do not necessarily form part of our central scenario).
Aristotle said that “probable impossibilities are to be preferred to improbable possibilities”, meaning that we find it easier to believe in interesting impossibilities (B52s on the moon, say) than in unlikely possibilities. The aim of this document is to seek those unlikely possibilities — out-of-consensus ideas for 2022 that we believe have at least a 30% chance of occurring. The concept was unashamedly borrowed from erstwhile colleague Byron Wien, who recently published his 10 surprises for 2022.
We believe the biggest returns are earned (or the biggest losses avoided) by successfully taking out-of- consensus positions. A year ago, the mood was hopeful on the back of vaccine optimism. Hence, our improbable but possible ideas were biased to the negative side (“S&P 500 finishes the year lower than it started”; “US 10-year treasury yield goes above 2.0%”; “Bitcoin falls below $10,000” were examples of ideas that didn’t work but that we have adapted for this year’s list). The mood is now mixed (given the Fed’s more hawkish stance) and so is our list – don’t look for internal consistency, as there is none.
1. S&P 500 closes the year lower than it started
In the last three years, the S&P 500 has generated total returns of 26.4%, 18.4% and 28.3%. There have been only nine occasions since 1915 when real total returns have exceeded 15% for three years in a row. However, they were grouped into four separate episodes, with three successive years going on to become four or even five years in three of those four episodes (1926- 1928, 1951-52 and 1997-98). That may give hope for 2022 but with a Shiller PE above 38, the market has rarely been so expensive and history suggests that S&P 500 returns over the coming 10 years will be limited (see Figure 1). On top of which, the Fed appears more hawkish than for some time (with three rate hikes a possibility this year, along with balance sheet shrinkage), which may bring short-term volatility.
2. US 10-year treasury yield goes above 2.50% With the 10-year yield currently around 1.76% (as of 7 January 2022), it is easy to see it reaching 2.00% but 2.50% seems more ambitious (our year-end forecast is 2.20%). In fact, it seems so unlikely that we think it worth considering, especially given the possible fallout. What could produce this outcome? We suspect a combination of strong economic growth (the great reopening), persistent inflation, rate hikes and balance sheet shrinkage could do the trick. We expect the inflation-adjusted 10-year yield to move towards zero (it was -0.77% on 7 January). We believe this could temporarily disrupt financial markets.
3. Travel & leisure outperforms on great reopening If any sector has been penalised by the pandemic it is travel & leisure. Figure 5 shows that the sector has underperformed the Datastream World Index by an annualised 10.4% over the last three years. Only Energy has done worse (-14.0%), while the top performing sector was technology (+17.1%). If there is a silver lining to Omicron it is the apparent weakening of the virus (in terms of symptoms). This may have brought us closer to being able to live with the virus, thus enabling a return to “normality”. We suspect travel & leisure would benefit enormously from that.