State Street Global Advisors, the asset management business of State Street Corporation (NYSE: STT), has today published its 2022 Global Market Outlook: Markets Continuing the Climb on macroeconomic trends and key investment themes for the year ahead. State Street Global Advisors believes that, as the market moves past peak momentum and accommodation, the current economic recovery, which will likely be uneven and multi-layered, will continue to deliver above-potential global growth in 2022.
High growth and inflation that dominated the macro narrative in 2021 will extend into 2022, but State Street Global Advisors expects the acute inflation worries to subside markedly by mid-2022 and a degree of “inflation rotation” to take hold – particularly in the US – as shelter-cost inflation intensifies and inflation pressures ease in other areas. While central banks in emerging markets have led the move toward higher interest rates for now, those in developed markets are expected to follow suit over the course of 2022. Although markets should continue to climb, certain issues and challenges do warrant an evaluation of asset allocations and investment strategies for downside protection.
“The Fed may accelerate the pace of its first-quarter 2022 quantitative-easing taper in order to prepare for its first rate hike, but there are many uncertainties around the pace of tightening – including uncertainties introduced by the emergence of the Omicron variant,” said Simona Mocuta, Chief Economist for State Street Global Advisors.
Gaurav Mallik, Chief Portfolio Strategist added, “Much of the inflation we are experiencing at the moment is ‘baked into the system’ due to past fiscal stimulus and supply chain challenges. Central banks understand that aggressive rate hikes can be ineffective and can also hurt growth prospects. Therefore, we believe central banks will focus on regaining control of market and investor expectations to ensure a steady and gradual normalization over the next two years.”
Fixed Income Market Outlook:
Amid a strong macroeconomic backdrop, the shift from monetary accommodation to tightening has begun, with central banks signaling that the first rate hikes since the pandemic began are on the horizon. While short-term rates have moved higher in response to potential rate hikes in 2022, State Street Global Advisors believes that the increase in yields and hawkish tone of the Fed could serve to accelerate the economic cycle; further flattening of the yield curve is therefore expected.
Lori Heinel, Global Chief Investment Officer, commented, “We consider riskier fixed income spreads to be a good source of carry and incremental yield over U.S. Treasuries in 2022. Spreads within riskier fixed income sectors, including investment grade and high yield credit, are expected to remain well-supported by strong fundamentals and foreign investors’ demand for yield. A more upbeat ‘rising stars’ backdrop will help enable a benign default and downgrade environment as well.”
Equities Market Outlook:
Caution is warranted as volatility in the equities market continues to increase. However, with the equity risk premium in both developed and emerging markets remaining above the long-term average, the average price-to-equity ratio for MSCI World standing at a sustainable level, and the outlook of corporate earnings likely to remain strong, State Street Global Advisors believes that equities offer attractive excess returns relative to other asset classes.
While the gradual steepening of the yield curve benefited financial stocks, the renewed government emphasis on hard infrastructure will support cyclical stocks, including industrial, materials, and energy companies. European equities, which offer attractive valuations relative to US stocks while showing strong earnings growth potential, are believed to be in a sweet spot because the region’s equity markets skew toward cyclicals. Emerging market companies, on the other hand, have yet to fully benefit from the reopening trade due to lagging vaccination rates, meaning that emerging market growth is likely to take shape only later in 2022.
“We expect markets to be less complacent in 2022 as monetary policy tightens and inflationary pressures continue. State Street Global Advisors sees an opportunity for active management over the coming years, and believes that investors may benefit from a selective approach to the equities market,” Altaf Kassam, EMEA Head of Investment Strategy & Research added.
In addition to issuing its 2022 macroeconomic and market outlook, State Street Global Advisors identified three key themes that are especially worthy of investors’ attention in 2022:
Getting the Most Out of Fixed Income
With rates stubbornly low, many investors are justifiably considering alternatives to fixed income that may offer more return potential. We think it’s important not to overlook the potential for certain areas of fixed income – including emerging market debt – to provide meaningful returns and yield enhancement. At the same time, focusing on return alone can lead investors to overlook the critical role that fixed income investments can play in diversifying portfolio exposures and providing liquidity, particularly for investors who have sought returns through exposure to illiquid private assets. In this year’s Global Market Outlook, we reiterate the role that fixed income continues to play as a critical portfolio diversifier and as a way to increase investment flexibility in portfolios where allocations to often illiquid alternative investments have grown.
Keeping Pace with the Climate Transition
We think that the transition to a low-carbon economy is best understood as a multi-dimensional shock event that will play out over time, with major regulatory and economic consequences and investment implications. Decarbonization, which is set to escalate, has second-order effects that could drive more participation from both developed and emerging markets, bringing enormous growth opportunities and improving the balance of trade for net energy importers within the current fossil fuel regime. Investors are reminded to remain alert to the regulatory and economic implications of transitioning to a low-carbon economy, while monitoring the increasing importance of stewardship and engagement, better climate disclosures, the modelling challenges around integrating ESG criteria and carbon pricing, as well as the structural effects of decarbonization on corporate earnings.
Reconsidering China Exposure
We believe that the macro rationale for investing in China remains intact despite the news headlines in recent months. The Outlook explains that Chinese assets’ low correlation to other markets, China’s structurally undervalued equities market, and Chinese bonds’ healthy yield premium relative to developed markets are reasons for investors to consider positioning their China exposure on a standalone basis, with a preference for active strategies.