By Joseph Little, Global Chief Strategist, HSBC Asset Management
Hard yards in the growth cycle
The global macro system is now mid-cycle – “the expansion economy” stage – meaning we are past the peak of GDP and profits growth, inflation picks up, and policy begins to normalise.
The prevailing combination of booming goods demand and hamstrung supply chains is set to continue as we head into 2022. Demand/supply imbalances, reinforced by gradual policy normalisation, will weigh on GDP. For the main economies, our scenario is that growth will be in a 4-5% range, with the UK and China towards the top, and the US and Europe towards the bottom. That implies we should expect high single-digit profits growth, even with rising costs pressurising margins.
The requirement to be realistic about growth is most obvious in China. Credit and regulatory tightening continue to depress economic activity. We expect a range of targeted easing measures to be introduced, but the strategy of common prosperity means that investors need to accept underlying growth in China is in the region of 5% for now.
One relative bright spot could be ASEAN, which has lagged badly, but should see a catch-up phase as economic reopening progresses.
Price pressures persist, for now
While forecasts for growth are lower, they’ve been raised for inflation. CPI inflation has gone above 6% in the US and is above 5% in the UK. Inflation trends are much more modest in China and Japan.
Our research suggests that in 2022, inflation around 4% is a reasonable base case. However, the inflation journey looks set to be complex, with the big prints front-loaded in the year. Many of the temporary factors that are boosting inflation now should shortly peak and soften by Q2. By mid-year, with supply chains repaired, these factors may even be exerting a disinflationary force. From then, the principal driver of inflation will become wages.
We think central bankers are right not to react too quickly. They will talk tough on inflation and could accelerate their tapering plans, but Fed policy lift-off probably won’t happen until the end of 2022. Meanwhile, global fiscal stimulus will contract.
The growth/inflation mix still seems favourable
We are no longer in the warp-speed economy. But the broad growth/inflation mix still looks favourable heading into 2022. We think the underlying regime looks rather like the 1990s, with an ongoing recovery, technological innovation, rising capital spending and policy experimentation. If that is realised, then in Q4 2022 inflation will be running at 2-2.5%. For 2023-25 we expect a 2-3% inflation range.
This means that investors’ fear of stagflation appears overdone. However, some parts of emerging markets look more susceptible. The ‘three Ds’ of weaker demographics – high debt levels, and a lop-sided distribution of wealth continue to weigh on long-term interest rates.
More uncertainty and more volatility
The biggest challenge for investors is going to be navigating the many economic and market uncertainties.
In terms of demand, a negative shock could come from a resurgence of Covid or from a hard-landing scenario in China. In either case, we don’t see a bad economic recession; but the risk is for a stalling-out of growth and renewed investor attention on a W-shaped growth profile. This badly damages the outlook for cyclical parts of the stock market.
The second risk is on the supply-side. Supply chains could take a lot longer to rebuild than assumed and there could be a more protracted impact from distortions in global labour markets. There is evidence of post-covid scarring, meaning “equilibrium unemployment” is higher than most economists assume. This could have serious social implications and mean central banks are wrong on inflation. Policy would have to adjust much more hawkishly, leaving limited places in markets for investors to hide.
Asset returns borrowed from the future
Investors have enjoyed bumper returns over the last 18 months, but these returns are, in a large part, borrowed from the future. Yields, spreads and risk premia have all compressed, and asset class expected returns are lower than they were.
A complex macro outlook is exacerbated by higher valuations and lower margins of safety in markets. We should expect cross-asset volatility to rise.
We see a solid investment case for global equities as stocks typically beat bonds while labour markets are improving. For now, financial conditions still look easy, the equity premium is reasonable, profits growth continues, and that should be enough for stocks to outperform bonds.
Rising bond yields should favour late-cycle and value equities (e.g. Europe, Asia). But given the macro complexities and the absence of growth surprise, we think the optimal strategy is to adopt a more cautious barbell approach, prioritising defensive stocks (quality, ESG, the digital economy) alongside cyclicals.
Parts of emerging markets appeal, especially in the fixed income area. The case for owning RMB bonds over global bonds seems strong – both for superior carry and portfolio diversification. Present risks notwithstanding, the future return profile of Asian credits looks very attractive versus the US and Europe.
Within alternatives, we focus on “real” strategies to support cost-effective inflation hedging. Global and Asian real estate, as well as infrastructure, look attractively priced. Secular re-greening, the transition to net zero as well as macro cross-currents should support selected commodities, including carbon, copper, and uranium.
Meanwhile, an allocation to venture capital and climate technology is a reasonable way to capture innovation and a way to manage the fear of missing out.
Altogether, 2022 looks like a more challenging environment for investors but there are still a number of interesting opportunities for active investors.
