17 Jan 2022
We believe that the long-term outlook is positive, with plenty of room for this market cycle to run, which should provide an uplift for stocks.
Covid-19 was one of the blackest of 'black swan' events in the last century, bringing global economic activity to a halt. Although the recovery in 2021 has been quicker than many people expected, it remains very uneven.
Unprecedented monetary and fiscal stimulus programs have left many parts of society financially better off today than they were before the crisis. Corporates and households around the world are sitting on much larger cash balances (figure 1 below) and, over the coming years, we expect those levels to normalise as people gain the confidence to spend and invest more. Continued spending should mean that corporate earnings growth remains strong.
Figure 1. Is cash burning a hole in corporates’ pockets?
Source: Bloomberg, S&P500 excluding financials: cash and short term investments over share, 30 October 2021.
Despite the reasons for optimism in the long run, there are some evident challenges that could present themselves in the next 12 months. Most pressing is that markets have delivered stellar returns in 2021 which has led stretched multiples. It is understandable that many, including us, are questioning whether there will be a pause and some profit-taking as we head into year-end?
We are very aware that margin pressure could create headwinds for stocks and general market confidence. This is a topic we are looking at very carefully.
Charts showing parabolic moves in input prices and transportation costs abound and the obvious question to ask is – will those prices be passed on to consumers? There are tentative signs that shipping costs might be falling (figure 2), but companies are still bemoaning supply chain issues and high prices when they report earnings.
Figure 2. Have shipping costs peaked?
Source: Bloomberg, WCI Shanghai to Los Angeles container freight benchmark rate per 40 foot box (USD), 30 October 2021.
The follow up question to consider, is whether demand strength and revenue growth means that earnings can increase even as margins compress. Thus far, cost-cutting in other areas has meant that margins have expanded this year. But that will not continue forever.
Q4 earnings could be vulnerable to some negative surprises. However, looking further ahead, increased corporate and consumer spending should allow for greater productivity and earnings growth, hence our more positive long-term outlook for equities.
As winter approaches, there are fears that the northern hemisphere will see another surge in Covid or flu cases and the return of social restrictions. Tragic as this would be, the impact on financial markets would be more benign as it would likely mean the persistence of easy fiscal and monetary policy. Maintaining an allocation to high-quality growth names makes sense, as those companies should perform best in this scenario.
Debt levels are a perennial concern but, while levels are high, the servicing costs have never been lower. For this reason, we think policymakers will be very slow to tighten policy. However, maintaining exposure to high-quality sectors and companies with better balance sheets offers defence against higher interest rates.
We have favoured equities over fixed income through 2021 and, while we do not foresee a crash in the short-term, we do temper our optimism a little as we head into year-end. This year has seen stellar returns for equities and there are reasons to expect some profit-taking.
Inflation and policymakers’ responses are key considerations, as are corporate earnings growth and the direction of margins. These should cause little more than wobbles in markets, but they do lead us to trim our equity exposure.
Long-term, bonds look far more expensive than equities. Meanwhile, the return on cash is derisory, and we do not expect an imminent recession. Therefore, we maintain our preference for equity over fixed income assets.
Risk warnings
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Important information
This is marketing material and is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable, nor are any prohibitions to trade before publication.
Where individuals or the business have expressed opinions, they are based on current market conditions. They may differ from those of other investment professionals. They are subject to change without notice and are not to be construed as investment advice