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Okay 2022 – what have you got in store?

Europe is facing a considerable conundrum

A new year usually means new problems. With the best of intentions, we make resolutions that usually crash and burn within the first few weeks. But we have control over those actions, whether they be giving up smoking, exercising more regularly or embracing the ‘vegan-uary’ spirit.

The big bad world, though… that has a power unto itself. So what does 2022 hold in store?

Should we expect more short-term pressure on the economic recovery, particularly in Europe where the growth in new covid infections is highest? Might more lockdowns in Europe materially impact risk sentiment?

Maarten-Jan Bakkum, senior emerging market strategist at NN IP, believes that in this environment of high uncertainty, the range of possible scenarios varies greatly.

“We could see a sharp fall in confidence and another drop in economic activity due to new health fears and disruptive lockdowns. But if Omicron does indeed turn out to be more infectious than previous variants but with milder symptoms, it could help us reach herd immunity faster with less hospitalisations. For now, we expect more short-term pressure on the economic recovery, particularly in Europe, where the growth in new infections is highest.” 

At the same time, he does not think inflationary pressures resulting from supply-side bottlenecks will quickly disappear. “Some of the expectations of monetary policy tightening are likely to be priced out again, particularly in the Eurozone, but we assign a low probability to a new directional change in the policy bias of the main central banks.

“As such, we are sticking to our view of the Fed hiking interest rates twice next year. We were not expecting a rate hike by the ECB before 2023 in the first place, but the chance of this happening has come down even more due to the recent virus developments.”

Increased restrictions

Daniel Morris, chief market strategist at BNP Paribas, agrees that futher lockdowns in Europe may materially impact risk sentiment. “Yes, in addition to inflation. The expected shift in demand from goods towards services will be postponed as travel and leisure activities are restricted.”

He adds: “So far, indications are that Omicron is more contagious but less dangerous. European governments are nonetheless likely to maintain if not increase restrictions through the winter, which will weigh on European equities. This is arguably the best case. The worst case is further indications of vaccine escape and a sharp increase in hospitalisations. This could well prompt a bigger sell-off in equities, though it would also cause the Fed to pause its seeming plans to accelerate tapering.”

Kevin Thozet, member of the investment committee at Carmignac, believes Europe is a bit of a conundrum right now. “On the positive side the policy mix (fiscal impulse) should remain favorable over the foreseeable future. But over the short term, the continent is stricken by persistently high energy prices, the covid winter wave and slowing export markets (China and other Emerging Markets).

“As such, despite a weak euro and positive fiscal impulse next year, we maintain our below-consensus 2022 growth expectations.”

Thozet says the economic recovery is expected to continue over the coming months, but the inflation and decelerating momentum as well.

“In such a context, we favour secular growth companies with good visibility. Indeed, lower leading indicators, lower profits growth, lower profit revisions are synonyms of lower risk taking going forward.

“So, we are looking for true growers; in theory anyone can generate revenue, we strive to invest in companies which are able to generate profits irrespective of the cycle. In that respect, so called covid winners are interesting investment cases. They should fare well in a tepid growth environment but are also expected to fare well in alternative scenarios.”

Tancredi Cordero, chief executive of Kuros Associates, thinks the best-case scenario is that interest rates will rise moderately, and tapering will be gradual and well timed. Should this happen, equity multiples will get repriced and companies with cheaper valuations will generally do better than high PE/PS ones.

He adds: “The worst-case scenario is that the Fed will be forced into raising interests rates too quickly. In that case it’s hard to make predictions. What is certain is that investors should look attentively to the fundamentals of their stock holdings.”

As to whether new lockdowns in Europe could materially impact risk sentiment, Cordero is clear.

“Certainly yes. On the one hand flows of capital would be redirected towards other geographies, and on the other European investors would certainly turn more bearish so to create a negative spiral.”

Emerging markets

Talking of other geographies, what are the prospects for emerging markets through 2022? NN IP’s Bakkum believes that so far they have held up well, overall.

He says the fact that the emerging universe as a whole has much more limited foreign financing needs than during the 2013 taper tantrum, assets from emerging markets have held up reasonably well in this period of rapidly changing Fed expectations. 

Thozet suggests the potential for higher rates and lesser liquidity calls for cautiousness on the asset class as whole and an increasing focus on selectivity. “But emerging markets appear as one of the few areas to escape financial repression and one of the few areas where we can find pockets of value.”

He argues that in fixed income markets, carry is attractive  – 2.5% in EUR-denominated Romanian 10-year bonds, local Russian rates at 8.5% on short-term rates, and that Brazilian spreads are not that far from March 2020 highs.

On equities, Thozet suggests the potential for China to shift its policy mix while the US is expected to tighten both its monetary and fiscal policy, should provide for a supportive backdrop for Chinese equities (but also sovereign bonds).

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