Equity strategy and market outlook – January 2022

In this month’s strategy piece Alastair believes that the recent market declines are best characterised as a ‘valuation tantrum’. The evidence is in the correlation between year-end valuations and the percentage decline suffered this year by sector and market. US markets, and the most highly valued sectors such as technology, have suffered the largest drawdowns. For the short term, markets may have reached ‘peak fear’. Implied volatility indices have risen sharply despite the absence of any new fundamental threat to earnings forecasts. To the contrary, news that national governments are removing COVID-19 restrictions even as Omicron infection rates remain elevated is a clear positive for the global economy in 2022. Concerns in respect of above-target inflation are rational but also at risk of being overplayed in the short term. Inflation readings are likely to fall back during the second half of 2022, provided energy prices stabilise close to current levels. Since November, US two-year rates have risen by over 60bp, a rapid rate of change, which gives the US Federal Reserve (the US Fed) an opportunity to dampen down expectations for any abrupt changes in monetary policy.

US/Russia tensions may persist over the medium term, with further sanctions likely. However, in our view the probability of an actual conflict between any US-backed forces and Russia remains low. We believe investors will continue to insist on a risk premium for securities exposed to Russia. Consensus 2022 earnings forecasts have continued to rise over the past four weeks, albeit modestly. Our favoured sectors of energy, banks and insurance remain close to the top of the EPS upgrade charts. Earnings momentum for European equities is currently outpacing the US.

European and ‘old economy’ sectors still appear better hunting grounds for returns in 2022. Energy sector profits are likely to be supported by currently strong commodity prices while financials should continue to benefit from rising interest rates. While non-US equities are not ‘cheap’ in absolute terms, many sectors are trading only a little above historical valuation norms and are priced to offer returns well above domestic bond yields. We maintain a neutral outlook on global equities for 2022 and expect January’s significant sector and regional rotation in relative performance to continue, albeit perhaps at a slower pace, during the year.

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