If 2022 proceeds as expected by the German asset manager DWS, no drastic portfolio changes will be required. Growth remains strong, inflationary pressures are easing, equities are benefiting from rising corporate profits, and although central banks retain control over interest rates, caution is warranted on bonds.
Author: Hanspeter Frey
In the pandemic, many things are different, including the economy and the financial markets. This was pointed out by chief investment strategist Stefan Kreuzkamp right at the beginning of the 2022 market outlook of the German asset manager DWS. The most obvious difference from previous trajectories can be observed in the economic cycle: Covid 19 set the economy back only briefly.
Consumption in particular has recovered unexpectedly quickly and strongly, with the result that supply is lagging demand. This created supply gaps, exacerbated by the transportation disruptions caused by the pandemic.
The economic cycle is different this time
This in turn drove up prices. Inflation is currently the most controversial topic on the market. Kreuzkamp gives the all-clear, at least in part: "The supply chain problems should gradually recede in 2022, and with them inflation as well. However, this will remain above the level before Covid broke out", specifically: around 2.8% in the USA and 2.6% in the euro zone.
Good growth prospects
Global growth remains intact, although momentum will weaken – not surprisingly after the spectacular recovery. DWS predicts GDP growth of 4.6% in the eurozone next year, slightly higher than the 4.0% in the U.S. For China, the forecast is 5.3%, assuming a temporary slowdown due to reforms.
The wave of regulation in China and the resulting turmoil in the markets are less a threat than a reform with a plausible background. It is a matter of better distributing wealth, for example, to make basic needs such as housing, education and health care more affordable.
The economic development will be more sustainable. The Chinese stock market will profit from this, said Sean Taylor, chief investment strategist Asia-Pacific. Taylor admits Asia in general has considerable potential to catch up in the post-pandemic period. He is positive about Japan, but also about India.
Tax and labor market reforms likely to fuel growth in India. The country has huge potential, especially in the technology sector. "32 billion in 2020, the Indian start-up scene is expected to grow by. US dollar 66% more capital mobilized than previous year", he explains, and that is just the beginning.
No interest rate hike in the euro zone, not even in 2023
In the same breath, and just as controversial as inflation, market observers are discussing central bank policy and interest rates. Chief strategist Stefan Kreuzkamp also has a strong opinion on this issue. Central banks did not lag behind the curve, but kept the scepter in their hands. The Fed is skillfully managing market expectations, which keeps long interest rates low, at least low enough not to become a serious problem for the equity markets.
DWS expects the first rate hike in the U.S. in the fourth quarter of 2022. In Europe, there is still no interest rate hike in sight "either next year or in 2023", says Kreuzkamp.
Fiscal policy, on the other hand, is a growing concern. In the USA, it now has a greater influence on the economy than monetary policy. As evidence, he pulls out the 4 trio. U.S. dollar, the record deficit in the U.S. national budget is approaching its peak. It exceeds the deficits in previous crises by a long way (cf. Figure), helping consumption in particular.
Lessons from the crisis
In step, and not without risk, debt is rising. What are the means against it? Saving enough is unrealistic. Higher taxes on the necessary scale would also be harmful to the economy. "The only way out is financial repression", Kreuzkamp holds. In other words, low to negative real interest rates resulting in slowly diminishing private wealth, as has been the case for some time now.
Hands off government bonds
Government bonds are not an alternative for asset preservation in this situation. What remains are high-yield securities with corresponding risk, inflation-protected securities and, as tangible assets, stocks and real estate, the latter primarily in central locations. "People are moving back to the cities after the pandemic", said Jessica Hardman, Head of European Real Estate Portfolio Management at DWS. In office real estate, he says, the trend is toward modern, environmentally friendly offices that cater to the needs of the next generation, i.e., next gen prime offices.
As far as interest rate investments are concerned, according to Bjorn Jesch, Global Head Multi Asset and Solutions, they are increasingly losing their role as a diversification to the other traditional asset class, equities. "We need to look for other asset classes to control risk in a portfolio and be ready for surprises."
In times of rising inflation, value stocks, listed infrastructure companies and commodities are advantageous, he elaborated. With growth picking up and inflation falling, growth stocks and real estate are more likely to benefit. Liquid alternative investments such as infrastructure or commodities are particularly well suited to guard against both of these risks.
"The toolbox needs to be significantly expanded to respond well to the challenges markets may hold for investors", recommends the multi-asset expert.
Stocks remain first choice
"Stocks will continue to be among the highest-yielding investments in the coming year, although the upside potential is significantly lower than in the current year", says Marcus Poppe, fund manager for global equities. DWS expects price increases in the mid single-digit range, supported by further increases in corporate profits. Further P/E expansion is unlikely, valuations are likely to have peaked, agree DWS augurs.
Europe or USA? According to Poppe, the answer depends on whether value or growth has the better outlook. Europe is value-heavy, Wall Street is strong on technology. He doesn't see investors' preference for growth stocks changing fundamentally.
Megatrend decarbonization
European equities are admittedly valued lower than U.S. stocks. But that does not mean they have higher price potential, he said. As long as real returns remain negative, growth stocks would likely continue to outperform.
Growth drivers decarbonization and technology
DWS sees decarbonization as a trend with great potential that extends far beyond the coming year. Clean technology is as important for industrials as it is for infrastructure companies and technology stocks, he said.
Decarbonization and technlogization go hand in hand. Both are megatrends and justify a valuation premium that will also persist in the longer term, based on strong fundamentals and the orientation of more and more companies to ESG criteria.