Key observations from 2021 and outlook for 2022

Key observations from 2021 and outlook for 2022

Despite the ongoing pandemic, 2021 was a positive year for most global markets. US equities returned close to 29% and ended the year less than 1% from a record high. By contrast, only a handful of markets, including China, were down on the year. Equity performance was supported by a rebound in economic growth and continued accommodative fiscal and monetary policies despite inflation rising to multi-decade highs. We make several key observations on the performance of markets in 2021:

1.?Equity markets proved increasingly immune to COVID-19.

Global stocks ended the year on a strong note, despite anxiety in the last months of the year due to the emergence of the omicron variant. The resilience of markets was consistent with the broad trend of the pandemic, with each successive wave harming equities less. In the three months from the start of the first wave (early February 2020 to April 2020), global equity total returns were negative 13.4% and US returns negative 11.3%. But from the start of the second wave in June 2020, subsequent three-month total returns for global and US equities were 6.6% and 9.4%, respectively. Following the delta wave, which started in May 2021, three-month total returns were 7.8% for global equities and 10.1% for US equities.

Looking ahead

We would expect the market impact of omicron to follow this trend, as has been the case so far. Omicron is spreading quickly, but available evidence points to it being relatively mild for vaccinated or pre-infected individuals. In our base case, we expect markets to gradually look beyond the fear of the virus and focus on the robust economic fundamentals. For investors, it is important to keep a longer-term perspective amid shorter-term fears, and we recommend staying invested.

2. 2021 was a good year for stocks, but not everywhere.

China, however, was the main underperformer. After reaching a record high in February, MSCI China declined over the rest of the year, driven by increased regulation of the technology and property sectors, energy shortages, and a slowing economy. The index delivered a return of -21.7% in 2021.

Looking ahead

We expect regional dynamics to follow a “two halves” pattern in 2022, with developed markets delivering unusually rapid economic growth relative to emerging markets in the first half, but in the second half, we expect emerging markets to deliver stronger economic growth. For China, ongoing virus restrictions, energy issues, and regulatory headwinds are likely to continue to weigh on economic activity through the Weekly Global 03 first quarter of this year. But we anticipate an acceleration in activity from 2Q22 as these headwinds fade and additional monetary and fiscal policy easing comes through. We expect Chinese equities to deliver mid-teens percentage returns in 2022.

3. Inflation surged; yields didn’t.

Few predicted that US inflation would end the year close to 7%. Yet the 10-year US Treasury nominal yield ended the year at just 1.5%. Even at the current level of around 1.77%, yields are still below the level that might be expected given elevated inflation. But while inflation has proven broader and lasted longer than expected, the prices of some goods and services most impacted by surging demand, such as used cars and apparel, have started to normalize. In 2022, we expect energy prices to stabilize and easing labor market frictions to reduce pressure on wages.

Looking ahead

We expect inflation to decline throughout the year, averaging 2.7% in Asia, 2.2% in the Eurozone, and 4.2% in the US. Against this backdrop, we think central banks are likely to scale back monetary accommodation in 2022, with the Federal Reserve leading other major central banks, as was highlighted by unexpectedly hawkish minutes from the December FOMC meeting. We now see three Fed rate hikes this year, starting as soon as March, but we expect officials to remain cautious about the risk of over-tightening. As a result, we expect only a gradual rise in rates and yields and expect the 10-year UST yield to rise from 1.77% now to 2% by June 2022. Investors looking to boost income will therefore need to consider unconventional yield sources, including US senior loans, private credit, synthetic credit, active strategies, structured investments, and dividend-paying stocks.

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