2022 Macroeconomic Outlook
21 January 2022 Sustainable Investing
Dealing with the spectre of inflation
As the world recovers further from the COVID 19 pandemic, we expect global GDP to grow in 2022. In fact, the world’s largest economies should exceed long-term GDP forecasts, with the US, EEZ, and China expected to grow by 4%, 4.3% and 5.1% respectively.
However, 2022’s big elephant in the room is inflation. Thanks largely to government stimulus, liquidity injections from central banks and the reopening of economies, consumer demand surged last year. Supply chains, still reeling from the pandemic, simply didn’t have the bandwidth to take on that level of demand. After a very benign decade, this has caused concerning levels of inflation to return1.
As economies are generally moving past recovery mode and growing well2, central banks should have the necessary leeway to address inflation by raising interest rates and winding down their bond buying programs through quantitative tightening (or QT). This has been signalled in the US3, and other leading economies should follow suit in the next twelve months (barring China which is currently going in the opposite direction).
So the most fundamental question for the next 12 months is this: after over a decade of unprecedented monetary expansion, how will the global economy cope with QT and how will financial markets react?
Riding the wave through earnings growth
2022 should be another year of mid to high single digit earnings growth for companies*. According to FactSet data, the S&P 500 (US) and Stoxx 600 indices (Europe) are expected to register respective earnings growth of 9% and 5.8% per share this year. Companies will still benefit from higher demand, but may also have leeway to modestly improve their operating margins through cost cutting and greater productivity. This means that equity markets can offset the lower valuations caused by higher interest rates through earnings growth.
Staying ahead of the curve
On the bond market, the yield curve is currently fairly steep, and steeper than it was just a few months ago**. This tells us that the bond market expects economic growth and continued inflation, which favours short-duration bonds over long-duration ones. So this curve will continue to be a vital indicator of how people view the current and future economic conditions. With that in mind, the US Federal Reserve will have to strike the right balance between raising interest rates and reducing its balance sheet without damaging the economic outlook that, in turn, could have a significant impact on the yield curve.
Keep calm and carry on
It’s clear that 2022 will present challenges due to inflation and QT, so equity markets may not perform as well this year. But we continue to believe that our climate-related themes will see growth and improving financial returns over the long-term, with the potential to capture hidden opportunities as market volatility increases.
With investing, your capital is at risk. The value of an investment can go down as well as up and performance is not guaranteed.
*Earnings per share (EPS) growth is a company’s net profit, divided by the number of outstanding common shares. As such, EPS indicates how much profit a company makes per share. So when a company’s EPS grows, it generally means it’s becoming more profitable, assuming the number of shares has remained the same.
**The yield curve plots the yields of bonds with the same credit quality, but different maturity dates. So a steepening yield curve indicates that the spread between short-term and long-term maturity is growing wider. When this spread narrows, the curve flattens. Bond prices are generally inversely correlated with the yield curve.