‘The fast bounce back in earnings growth and equity market returns over the past year was always going to peter out,’ writes Romain Boscher, global chief investment officer for equities, in Fidelity International’s Catch-2022: An investor’s guide to the year ahead for the global economy. ‘That process has started and will continue through 2022. The question is whether we will have a soft or hard landing.
‘At the moment, a soft landing looks more likely for equities, but a number of risks could drag the market into something more unpleasant. In this climate, having a robust portfolio biased toward quality is key.’
The biggest risks facing equity markets are high valuations and narrow leadership, Boscher warns. Fidelity’s investor guide to the year ahead states that although valuation multiples are high, they are ‘not unprecedented considering the limited alternatives’. That doesn’t mean a correction isn’t on the cards, though. Valuations are near the top end of the spectrum on several measures, says Boscher – something that ‘could invite a correction’.
The other big equity risk is that market leadership is concentrated in a small group of stocks. Fidelity says this means ‘any weakening of sentiment could lead to a rotation – at the expense of mega-cap names’.
But Boscher outlines a number of risk factors with the potential to impact the equites market: slower earnings growth, higher inflation and interest rates, disrupted supply chains, high debt levels and the regulatory storm in China are all primary risks.
Some of these risks – such as strong demand for certain goods and services as a result of the global economic reopening and resulting supply-chain bottlenecks – are transitory, but Fidelity also warns that others – including wage inflation and climate change policies, for example – have the potential to be ‘tenacious drivers of inflation’.
Boscher further notes the continued impact of Covid-19. ‘The virus is here to stay,’ he writes. ‘Covid-19 is turning into a more persistent drag on growth; vaccines are proving effective in breaking the link between infections and hospitalizations but not in stopping cases altogether.’
Coming back to China, Boscher says that as well as keeping an eye on the regulatory crackdown that has been affecting different sectors in China, investors should look to the country as an indicator of what to expect elsewhere. ‘Not only is it a big market in its own right but it was also among the first in and first out of lockdowns, and the first major market to show signs of earnings fatigue,’ he writes. ‘Its performance in the coming months may indicate how things will play out in developed markets.’
Despite predicting a ‘soft landing’ for equities in 2022, Boscher advocates for ‘robust portfolios with a quality bias, limited leverage and not too much exposure to China.’
Fidelity International’s wide-ranging look ahead offers a guide to investors across macro issues, multi-asset investments, equities, fixed income and real estate under the umbrella theme of ‘The policy paradox’.
Invoking Joseph Heller’s 1961 novel Catch-22, Andrew McCaffery, global chief investment officer for asset management, writes in the report introduction that ‘2021 brought the recovery many had hoped for. Businesses reopened, commuters returned to their desks and the bravest of us even went on holiday. But no one could describe it as ‘getting back to normal’ amid rocketing energy prices, high debt levels and past-the-peak growth.
‘These conditions increase the risk of a policy mistake in the next 12 months as central banks and governments try to navigate various ‘Catch-22’ (or Catch-2022) narratives… without losing the trust of markets.’