The outlook for 2022 is more uncertain than 2021 was at this time last year. Last year the vaccination rollout was accelerating in developed markets and opening up was being planned. EM vaccination is still limping along and the emergence of a new variant shows how the pandemic will not be over until it rises meaningfully. Waning efficacy from first vaccinations in DM is also leaving it exposed to rising cases. On top of this, inflationary pressures are forcing central banks to rethink policy settings and the risk of a mistake is elevated.
Equity market valuations remain stretched and earnings growth is slowing. In our view, this combined with the pandemic backdrop means volatility will increase and corrections are likely. Investors should buy the dips with cash or reduce fixed income positions into risk assets. The yield curve is flattening after peaking at historically relatively low levels. But alarm bells aren’t ringing yet – equities are still cheap relative to bonds.
Australia remains our preferred equity market exposure, followed by EM and Japan. Australia has a stronger earnings growth outlook than EM, but slightly less attractive valuation. The US and Europe are our least preferred markets, with valuations extremely stretched even though there is room for further upgrades to EPS growth.
Global property is our preferred defensive asset class ahead of global government bonds and Australian government bonds. Credit spreads are historically tight and valuations in global infrastructure are also stretched. We retain low levels of cash, given we expect returns on growth assets to exceed returns on defensive assets, but double-digit returns aren’t likely.
Buy Growth in Australia and Value in the US. The attractiveness of equity style varies between markets. In Australia, we think the recent run of outperformance by Growth can continue well into H1 2022. However, in the US, Value’s EPS growth outlook has been upgraded and it offers relatively better valuation to the risk- free rate than Growth.